Many people find it hard to separate their emotions from their investment strategy. Buying stocks can be stressful for some, as individuals try to time the market to find the “perfect time” to commit their funds. “What if I buy too soon and the share price decreases?” “What if I wait too long and the share price increases?” If you find yourself asking those questions, dollar-cost averaging could be a great strategy for you.

How Dollar-Cost Averaging Works

Dollar-cost averaging (DCA) is an investing strategy used to manage risk when buying stocks, exchange-traded funds (ETFs), or mutual funds. In dollar-cost averaging, an investor invests the same amount of money in the same security at regular intervals over a defined period of time, regardless of the security’s price.

Dollar-cost averaging is used to help reduce the impact of volatility. By buying on a regularly-defined schedule in a market that is moving both up and down, an investor will receive more shares at lower prices and fewer shares at higher prices. Both beginner and long-time investors could benefit from employing a strategy of dollar-cost averaging.

4 considerations before using DCA:

1. How much money do you want to invest?
2. Over what time period?
3. How often do you want to invest? (ensure that your total investment over the chosen time period is broken into equal amounts based on this number)
4. Regardless of the share price, maintain discipline and consistency in following your plan.

DCA as an Investment Strategy

In essence, using DCA as an investment strategy can help ease an investor’s desire to time the market to buy at the lowest price. An “advantage” of dollar-cost averaging is that it helps minimize the negative effects of investor psychology and market timing on an individual’s portfolio. By committing to DCA, the potential to make decisions out of greed or fear could be reduced. Panic-selling when prices decline or buying more when prices are increasing are not an option when using this approach.

DCA aligns with the perspective of many long-term investors, in that this strategy assumes that regardless of short-term movements, prices are expected to rise over longer time periods. Dollar-cost averaging could help prevent an individual from poorly timing the investment of a lump sum at a potentially higher price.

Another benefit of dollar-cost averaging is that it could help ensure an investor is getting their money to work for them on a consistent basis. This is a critical factor in long-term investment growth. For this reason, dollar-cost averaging is sometimes referred to as the “constant dollar plan”.

Investors who use dollar-cost averaging will generally lower their cost basis in a security over time. In its most simple form, cost basis is the original purchase price of an asset. A lower cost basis will lead to less of a loss on investments that decline in price, and generate greater profits on investments that increase in price.

Calculating Your Dollar-Cost Average

To calculate your dollar-cost average in a given security, you simply add up the total dollar value you’ve invested into the security, and divide the total by the number of shares you’ve purchased.

via The Motley Fool

When Using DCA May Not Be Recommended

As with all investment strategies, DCA is only as good as the security or securities that an individual chooses. An individual must ensure that they’re taking into account both their outlook for a specific investment and the broader market when making the decision to use DCA as a strategy.

Depending on the defined period of time an individual plans to employ DCA as their investment strategy, DCA may not be recommended during time periods when prices are trending steadily up or down.

For beginner investors or those who are less-informed, DCA is less risky when it is used to buy index funds instead of individual stocks. Using DCA to invest without researching the details of a given security has the potential to cause an unfavorable outcome. In this situation, an investor may continue to buy when they otherwise would stop buying or completely exit the position if they had done their research.

Make Informed Decisions for Your Financial Future

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This material is intended for informational purposes only. It should not be construed as legal or tax advice, and is not intended to replace the advice of a qualified attorney or tax advisor. This information is not an offer or a solicitation to buy or sell securities. The information contained may have been compiled from third party sources and is believed to be reliable.