The Advantages of Dollar Cost Averaging
Markets go up and markets go down. This is completely normal, and is known as market volatility or risk. The Raiz Philosophy is to invest small amounts regularly, even in falling markets as this can help you to ride out the downturns in the market and is one of the keys to having a healthier balance over the long run. This is the well-known principle of Dollar Cost Averaging. For more information on Raiz fees, click here.
How does it work? For example, say you have $1,000 to invest. Instead of investing it all at once, you could invest $100 each month into the market for 10 months, despite the changes in the market value.
If for example the stock of choice was priced at $10 the first month, you would purchase 10 units. If during the second month the stock was priced at $5, you would purchase 20 units, and so on.
In the end, you would have purchased more shares when prices were lower and fewer shares when prices were higher. The outcome is that you may have invested more prudently than simply investing the money all at once in a lump sum.
Let’s look at the other key advantages to sticking with Dollar Cost Averaging (DCA):
Avoids Bad Timing
Investing in one lump sum and trying to pick the best price to enter the stock is known as market timing, and is something very difficult to do and get right.
If an investor could have any superpower in the world, it would be to pick the low points of the market. Many have tried, succeeded and failed but no one knows exactly when the lows and highs will happen, and no one can stop unwanted surprises from happening.
Dollar Cost Averaging can provide a disciplined strategy as it ensures you are not too exposed to falls in the market when you buy at the top; and rewarding you when the market recovers, for buying when the market was falling.
By not depending on the timing, DCA can smooth out the market’s ups and downs.
Reduces Risk
Dollar Cost Averaging is most effective in a long term saving strategy. As the market moves up and down, dollar-cost averaging over time reduces your risks of trying to pick the best times to invest from these swings.
By viewing falling markets as buying opportunities, you can significantly enhance your long-term return potential when the market rebounds.
Removes Emotional Investing
People often make decisions based on emotion or loss aversion. Loss aversion refers to an investor’s tendency to strongly prefer avoiding losses to acquiring gains.
Studies suggest that losses are twice as powerful, psychologically, as gains, leading this type of investment mindset to be more likely to make the mistake of needlessly selling holdings and switching to cash in a down market.
By avoiding the media hype or fear in picking the ‘right time’, investors can avoid both the euphoric and depressive investment traps.
A Dollar Cost Averaging strategy is in line with the Raiz’ philosophy and provides a disciplined strategy.
