In this article and featured video, Kevin Ellman CFP® discusses the benefits of Dollar Cost Averaging.
Most people working today have had some experience with Dollar Cost Averaging or DCA. Basically this technique means that you will invest a certain amount of money every week, month or quarter. Sounds a lot like a 401(k) doesn’t it? If you have a 401(k) you invest a certain percentage of your paycheck each and every payroll no matter what the market is doing. This is Dollar Cost Averaging in the workplace.
Why is that good?
For two reasons, first, you are saving first and spending what is left over. In this way you constantly add to your long term savings. In my opinion, most people, who spend first and save what is left over, rarely save very much. How many people do you know who have “extra money”. This kind of automatic savings plan provides a system and a discipline that I believe is good for most people. Second, investing a steady amount every month means you buy a few more shares when the market is down and a few less shares when the market is up. For example, let’s say you invest $100 a month.
If the shares you are investing in are trading at $5 @ share, you buy 20 shares. If those same shares a month later are trading at $10 @ share, you buy 10 shares. Essential this means you buy more shares when the price is low. Sounds a lot like the first half of “buy low-sell high”. Left to their own devices most people will buy less when the market is down, they are afraid it could get worse. And of course it could. Many will also buy more when the market goes up, fearing they will miss the run-up. And of course they might.
This is the exact opposite of the DCA approach, which we advocate. If you are a long term investor and you believe as I do that the overall stock market will go up over the long term then this disciplined investment method can again stack the deck in your favor by accumulating more shares over time. While dollar cost averaging can be a good choice in minimizing timing risk, it does not assure a profit and does not protect against a loss in declining markets.
Dollar cost averaging does not assure a profit and does not protect against a loss in declining markets. This strategy involves continuous investing; you should consider your financial ability to continue purchases no matter how prices fluctuate.
Asset allocation does not protect against loss of principal due to market fluctuations. It is a method used to help manage investment risk. Past Performance does not guarantee future results. This material is for informational purposes only and is not meant as Tax or Legal advice. Please consult with your tax or legal advisor regarding your personal situation.
The opinions expressed are subject to change with economic and market conditions. They are not meant as investment advice. Forward looking statements and market forecasts cannot be guaranteed and may not come to pass.