Dollar Cost Averaging
When should I invest? How much should I invest? What should I invest in?
Investing can be overwhelming and complicated. Trying to time the market is an added stress and can frequently cost you.
Dollar Cost Averaging is the strategy when you want to K.I.S.S..
It’s a straightforward strategy in which you don’t have to adjust to the changing market. It benefits those who invest regularly.
The Dollar Cost Averaging method is when you invest a fixed amount of money in regular intervals over an extended period, regardless
of the share price. Using this method, you aim to lower your average cost basis.
Assuming the market will rise and fall but continue to rise over time eliminates the need to try and time the market.
How Dollar Cost Averaging Works
By using the Dollar Cost Averaging (DCA) method, you avoid having to time the market. Because, let’s be honest, most investors can’t time the market.
Less than 10% of financial advisors successfully time the market. And there’s only a handful of people that have successfully timed the market over extended periods.
Example
Investor “A” uses the Dollar Cost Averaging method. They buy the same ETF every month in increments of $500 with a total investment of $6,000.
Month Amount Share Price Shares Purchased
Jan $1,000 $25 40
Feb $1,000 $25 40
Mar $1,000 $25 40
April $1,000 $20 50
May $1,000 $10 100
June $1,000 $25 40
Total Invested Avg. Share Price Total Shares Purchased
$6,000 $21.67 310
Investor “B” either invests on a whim or tries to time the market. Like most investors, they buy when the market is up and everyone feels good about investing. They also buy an ETF with a total investment of $6,000.
Month Amount Share Price Shares Purchased
Jan $6,000 $25 240
Feb $0 $25 0
Mar $0 $25 0
April $0 $20 0
May $0 $10 0
June $0 $25 0
Total Invested Avg. Share Price Total Shares Purchased
$6,000 $25 240
With the Dollar Cost Averaging model, Investor “A” was able to take advantage of the market downturn in April and May. Even though they paid the same share price as Investor “B” for four out of the six months, they still had a lower average share price of $21.67.
Sure, investor “B” could have invested on a whim or timed the market and invested all their money in May. If they had done that, they would have done great!
However, getting lucky and investing on a whim isn’t a tried-and-true game plan. That’s like playing the lottery. As I mentioned earlier, most professional investors can’t accurately time the market. So, timing the market is essentially gambling.
With the Dollar Cost Averaging model, Investor “A” bought 70 more shares at a $3.33 discount per share.
Pros with Dollar Cost Averaging
- Good investing habits
- One of the best pieces of advice I’ve received from a financial advisor was to set up automatic contributions.
It’s easy to get caught up with life and forget to make the necessary investments to hit our goals. Or to spend that money on something else that we “need” now. My kid’s 529 plan is on automatic monthly contribution because that isn’t really top of mind for me.
All my other investments are on my calendar for the first Monday of every month. It’s easy for me to keep up because I’m always in it.
- One of the best pieces of advice I’ve received from a financial advisor was to set up automatic contributions.
- You’ll be able to take advantage of opportunities
- If you’re investing regularly, you could catch the down markets. Depending on my cash flow, I will often make my regular contribution with an additional amount added when the market is down.
- Keeps emotions out of it
- “Be fearful when others are greedy and greedy when others are fearful.”
Great advice from Warren Buffet but easier said than done. Our emotions can sometimes take over and keep us from staying the course. We get excited when the market is up or moving up and scared when it’s down or going down.
That’s natural. Automatic contributions help avoid this. Set it and forget it.
- “Be fearful when others are greedy and greedy when others are fearful.”
- Reduces the stress of when and how much to invest
- Create your plan, then set it and forget it. You can revisit yearly and decide whether to add more to your regular contributions or pull back. No need to think about it any further than that.
- Create your plan, then set it and forget it. You can revisit yearly and decide whether to add more to your regular contributions or pull back. No need to think about it any further than that.
- Risk reduction
- Your buy-in is averaged out, so you reduce the risk of buying at the top of the market.
Who Should Use the Dollar Cost Averaging Approach?
Everyone except those who can beat the market over an extended period.
Unless your name is Ray Dalio, Warrant Buffet, Carl Icahn, or James Simons, you should use the DCA method. Warren, if you’re reading this, call me.
If you want to gamble, go to Vegas.
Seriously, that’s what you’re doing when you try to time the market. The odds are not in your favor.
Sometimes people time the market well. Some…times. Very infrequently, they do it over an extended period.
This means they lose their gains when they don’t time the market.
If you want to gamble because you like the rush, go for it. Take a portion of the investable assets you don’t need and use them to time the market.
That’s right, assets that you don’t need because you have to be willing to lose them. Go find some of those assets you genuinely feel you don’t need after you’ve worked so hard to attain them.
It’s exciting to win big. But we all know that slow and steady wins the race. Keep it consistent, keep it steady and keep it growing.
