Investment Strategy: Dollar-Cost Averaging Method

Smooth out market bumps with Dollar-Cost Averaging — Invest smarter, not harder.

Many think of investment as a venue reserved for those with big capital. After all, it does seem like that. If you just have $100 to invest in a month, and say, your portfolio went up by 10%, that’s $10 for you. Take out the fees, commissions, and all other cuts — you’re left with what, a $7 gain?

It might not seem worth it, and the market is volatile, you might not even get that $7 — or so you think. That’s where the Dollar-Cost Averaging (DCA) method can be employed.

What is Dollar-Cost Averaging method?

It’s a fancy way to call a strategy that essentially tells you to invest in the same asset (same amount too) regularly.

It’s kind of like when you take a certain cut out of your pay and put it in a piggy bank — but unlike your piggy bank, your money can grow (or shrink) when you invest it.

The strategy is where you decide on an asset that you think has long-term potential but is somewhat volatile over the short term.

The whole purpose of employing this method is for you to ‘diversify’ the price at which you bought the asset so that when it comes out in the end, the average money that you spent on the asset came out somewhat lower.

How Dollar-Cost Averaging Works?

First, you need to do a bit of research to look for a type of asset that has a high potential for long-term growth. Just a tip: you should consider assets that are more volatile in nature (such as stocks and funds) rather than stable assets like bonds and savings accounts.

Once you have the asset you want, say, you want to invest in Apple stocks (NASDAQ: AAPL), you set a time interval in which you will buy a certain amount of Apple stocks.

For example:

Since I can invest around $200 a month, given my salary, Apple’s stock price has been hovering at around $120 to $170.

I can afford to purchase one Apple stock a month. With the remaining money, I’ll try to diversify my portfolio by looking for other stocks to invest in

If you want to follow it to a T, you should set a certain date in the month when you will make the purchase regardless of the asset price. Say, set it a day after your payday, or perhaps in the middle of the month.

Some set a certain span of time — say, on any day during the third week of the month — to give themselves more flexibility in choosing a day when the price is the lowest.

Here’s a tip: Try to look if the asset you want to invest in has a certain pattern in its price. Some companies may rise in price closer to payday when people spend their pay on these products for self-reward, etc.

Note: Don’t get confused, if you have your own goal of saving money in savings account regularly that is excellent. DCA is not like a savings account, it is when you want to invest your money — take a risk with the ups and downs — while wanting to minimize the risk.

How Dollar-Cost Averaging Minimizes Risk/Portfolio Volatility?

There are generally two ways to invest. Either you save enough money and invest that big sum whole, or you invest regularly through the DCA method.

If you invest in a huge sum, you gain the advantage when your investment is spot on, you can be looking at profits of thousands of dollars. However, that is if it works, if it doesn’t, then all that time you took to save that bulk of money may turn to dust.

So, in that sense, if you invest, $100,000 in a bulk. If the gain is 10%, you gain $10,000. Tempting, but if you lose 10%, that is $10,000 lost.

In addition to that, people who invest in bulk are usually investing at a later point in their life (because they need time to save that money). So, they might not have much time to recover from their losses.

Now, moving on to DCA, when you buy the asset regardless of the price, as long as it is at a certain time you decided, there will be times when you buy it at a high price, but there would also be times when you buy it low.

In the end, it may actually take you, say — $10,000 to buy 100 shares in Company ABC over the course of 5 years, whereas someone who invests in bulk may have to buy 100 shares in Company ABC at $10,500.

Simply, DCA is where you just invest regularly, so that you can be investing when the stock is up, or when it is down, but all of the buys you made — if you look into the average — you’ll find that it’s not too high (nor too low either).

Pros and Cons

Pros

Less research is needed.

When you invest using DCA, your main research will be focused on whether the asset is still a good buy for a long-term interval. Whatever events that affect short-term price movements may not really concern you.

Good investment habit.

This method is especially good for those who are just getting started with investing. It creates a sense of discipline for you to put aside the money that you could’ve used to buy another house plant that will eventually perish under your care — and watch as the stock moves up and down.

Bring down the risk.

When using the DCA method, you sometimes buy at a high, sometimes at a low, but if you look at the average price you spent purchasing the stock, you can see that your purchase is moving at a moderate level despite how volatile the stock is.

The asset you like may not be as cheap later.

Some save their money to invest in bulk on assets that they have aimed for, but the thing about saving is that it takes time — it could be months or even years, and by the time you’re ready to buy, it may not be as cheap or as full of potential as before.

Compounding interest.

If you invest in stocks or funds, you may be entitled to dividends. If you start early, your dividend pays will start early — so when you sum it up, you can make actually quite a lot in dividends over time.

Cons

There can be times when you buy ridiculously high.

One of the most apparent downsides of DCA is that sometimes you can be buying stocks at a ridiculously high price. Since the discipline of the DCA method is to buy regularly at a given time, then you might be walking heads on towards a towering price.

Price can fall.

Your main concern when using the DCA method is for you to make long-term gains, but the stock that you have been investing in regularly may fail you. You can try to invest in giants, but even giants can fall sometimes. That’s why you always have to be abreast of current issues. Perhaps not as intensive as active traders, but just to get the general picture.

You need to allocate your money in accordance with the asset price.

This strategy can be a bit cumbersome to those that have a limited amount of money to invest over the period. Say, you can only allocate $100 monthly to buy XYZ stock, but the price apparently goes up to $150, now that’s a bit off from your allocations.

Fees and commissions.

One thing that you may want to consider when using the DCA method is the money you lose from paying for fees and commissions. Some brokers charge a flat rate per transaction. So, the less you transact, the less you’re paying in fees. You need to factor in the fees and commissions into your account balance.

Only good for stocks that are moving up and down.

DCA is employed so that you can buy assets at a lower volatility rate, or lower average price spent when purchasing a certain number of assets. That will work if the price is moving up and down since you might be buying at a high or you might be buying at a low. If the price is constantly going up, you’re simply buying fewer and fewer assets, up to a point that it may not be that viable anymore.

Also read:
Types of Stock Trading Strategies

Bottom line

In conclusion, the Dollar-Cost Averaging (DCA) method is a good investment strategy for those who want to minimize risk while still being able to invest. You should first have an asset that you want to buy, and instead of saving money to buy a bulk of it, you simply buy a few of it according to how much you can afford. This method has its pros and cons which you should consider.

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None of the material above or on our website is to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument. Investors should carefully consider if the security and/or product is suitable for them in view of their entire investment portfolio. All investing involves risks, including the possible loss of money invested, and past performance does not guarantee future performance.

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