What is Dollar Cost Averaging?
Dollar Cost Averaging is an investment strategy designed to reduce volatility in a portfolio by splitting the total amount you want to invest in an asset into smaller parts, rather than purchasing an investment all at once. These smaller parts automatically invest at regular intervals over time regardless of the price of the asset at each interval.
So if you decide to invest $500 into an index fund this year, but don’t want to do it all at once, you can start investing $100 a month irrespective of the price per share each month.
This way you take out the stress of ‘timing the market’ and remove any emotion from the equation. By committing to a set schedule, you don’t have to worry about potential price movements, reducing investor anxiety and fear of missing out.
When you dollar cost average, you invest a specific amount periodically regardless of the price of the asset, “low or high”. The basic rule of investing is to “buy low and sell high”. Dollar cost averaging is a strategy that tries to minimize those risks by building your position over time. By splitting up an investment purchase over a period of time, you decrease the chance of the inverse taking place, as in buying high and watching it go lower.
Over time, dollar cost averaging can result in lowering your investment costs per share and boost your returns. The strategy also helps investors avoid making the mistake of investing a lump sum just before the price per share of the asset goes down due to volatility. The underlying idea is to test the current rather than diving headfirst with your money by purchasing the investment at an average price. This will decrease your chances of overpaying.
Averaging your investments over time → better diversification.
You can dollar cost average into any type of investment, may it be $TSLA, Gamestop, or Bitcoin, but the strategy is most commonly used with more diversified products like mutual funds, index funds, & ETFs rather than in a single stock/crypto over long periods of time.
It’s impossible to predict whether prices will go up or down in any particular time frame, but there is a century’s worth of data showing that markets do rise over time. Using this strategy in an individual stock/asset without research can be dangerous as one could continue to invest in an asset with continuously declining market prices. Dollar Cost Averaging is not a catch-all against doing your own research and understanding what you’re investing in.
Like every strategy, dollar cost averaging is one of many strategies people can apply and it comes with its pros and cons. Doing further research into the strategy and the specific assets you’re interested in will be the key to being successful with the strategy.