Dollar-cost average(DCA) investing, an essential and popular investment strategy, disperses risks by pricing misjudgment. Investors use it to lower investment prices and increase portfolio returns. Yet, you should entirely be sure of grasping the technique so you can profit from your investment from it.
A perfect investment strategy does not exist, but sound investing tactics may improve your performance. Dollar-cost average works for your portfolio if you deploy it appropriately.
You may have heard that DCA investing may not work in a declining market. It depends on circumstances and when you implement the strategy. The following is the first one you need to know.
What is DCA?
DCA is about regularly investing in a stock or more with the same investment amounts, irrespective of its prices. Through consistent buying of the same stock, you obtain different stock prices for a stock. You will get an average price for the stock bought multiple times in the past.
Through the dollar-cost averaging strategy, you may find a median stock price, which is the sum of all investment amounts divided by all the units of stocks. The median price becomes the basic cost for the stock.
A dollar-cost averaging example
You are interested in investing in the ABC company. Half a year ago, ABC’s stock price was $50 when you bought the stock for the first time with a fixed amount of $1,000. When a stock price gets higher, you buy fewer shares; you can get more shares when the price lowers. Over the subsequent 6 months, you’ve purchased the same stock with the same amount 6 times.
The respective prices for the 6 purchases are $50, $45, $43, $48, $53, and $50, with a total investment amount of $5,893, and the number of stocks bought is 123. The median price is $5,893(the entire investment amount)/123(number of stocks) = $47.91. If you sell all the stocks at $50, you will get a $2.09 profit. You have a return of 4.36% at a beginning-of-an-investment stock price after 6 months.
Benefits and Risks of DCA
Advantages
1. Risk Reduction
If you invest in an asset with different prices for a time, you may spread pricing risks for an investment. You have created a median cost for your investment through consistent purchases because multiple buys have averaged out the highest and the lowest prices. The advantage is you need not be concerned about missing the best prices.
2. Disciplined Investing
Investing requires time, effort, and consistent behavior. Besides, a solid commitment to a successful investing schedule is necessary to complete a coherent dollar-cost strategy. The more consistent you stick to your plan, the more likely you will succeed.
3. Double benefits
You may enhance your portfolio performance by combining DCA investing and ETF investing. Except for cost reduction brought by dollar-cost averaging, you may benefit from the lower risks by investing in an ETF holding many stocks at a time.
Criticisms
1. Target Asset Allocation
The investment portfolio may have a prolonged downward time. If your investments are undergoing a long downsized moment, you may lose money like in a stock market. Consistent buying may worsen the performance of your portfolio determined by the asset allocation decisions.
2. Transaction Costs
Compared to a lump sum investment, dollar-cost averaging(DCA) requires higher costs due to multiple transactions. The strategy may add to higher costs for investors if transaction costs form a significant part of an investment portfolio. Instead, you should choose low-cost investments like Exchange-traded funds(ETFs) and mutual funds to lower your costs. Learn more on how to buy ETF in Singapore.
3. Administration costs
You may set up a ledger to record and monitor your regular investments due to more transactions and related costs for a DCA than a lump sum investment. You may spend time and resources managing your portfolios.
Why Use Dollar-Cost Averaging?
Dollar-cost averaging(DCA) should be a part of your investment strategies because the benefits are multifold. You may gain more by using it.
1. Add-on value
To maximize portfolio return, you should include the dollar cost average as one of your investing tactics. Unlike lump-sum investing, DCA can diversify the price risks as investors can reduce or eliminate the loss from investing at too high a price. The strategy can complement, not exclude, other investing techniques.
2. A scientific approach to investing
Once you determine your target, you stick to your investing plan no matter the ups or downs of the market. You keep on the course without panic selling or irrational buying. Emotional investing does not have a place in the DCA because human factors play a minor role in investors than others.
3. Optimism about market
Stock investing is one of the ways of creating wealth. To be successful in the unpredictable and volatile environment, you should adhere to a disciplined investing habit to reach your goals. Most stocks in major markets have an upward history despite numerous short-term ups and downs. DCA is a fit for mid-to-long-term investors.
Dollar-Cost Averaging vs. Buying the Dip
Dollar-cost averaging works to grow your investment portfolio more than lump-sum investing. Dollar-cost averaging investors can benefit from unit-cost averaging through the “ much lower prices, more units purchased.” Your portfolio becomes more liquid as the lower prices bring more units with the same investment amount. When you buy a mutual fund or a stock, you can buy more units to add to your portfolio when the price is lower.
However, if you buy the dip in the market, you only have one or fewer price entry points.
The market may go down further, and the dip buyer will lose due to the fall in price. But dollar-cost average investors can reduce losses due to the spread of pricing risks through multiple purchases.
Dip buyers may need to focus on one price with high stakes, while dollar-cost averaging investors can spread the risks and keep investing in the same mutual fund or stock by avoiding the fear of buying at high prices.
Unit-cost averaging investors may bear more transaction and administration costs as more activities and deals occur. On the other hand, buy-the-dip investors buy at one price and pay fewer costs.
Is Dollar-cost Averaging right for You?
If you plan to invest for your future, you should ask the following questions and give precise answers before you throw up a sum of money or use a dollar-cost average for investing.
1. Commitment
Billionaire investor Mr. Warren Buffett says wealth accumulation takes time. Especially for dollar-cost averaging investing, you should adhere to an investment plan stretching for some time, for example, 5 to 10 years or more. In the forthcoming time, you may see fluctuations related to your investments. You should stick to your schedule and continue to invest with determination no matter what is happening to the market.
2. Time horizon
Risks spread over time. As an investment period lasts longer, asset volatility becomes less. Besides, more entry prices can lower asset price vulnerability brought by a single price, particularly during market turbulence.
3. Monitor and review
Monitor and review are critical to your dollar-cost average investing plan. You have to carry out multiple investment transactions, unlike lump sum investments, and costs related to transactions and administration may increase substantially. A good review and monitor system may help you do the job. Besides disciplined investing habits, you need a habitual behavior to reevaluate your investments concerning costs and performance.
Though most financial institutions provide automated systems to help clients review their investments, you should examine your portfolio costs and performance to meet your goals. Regular supervision ensures you can minimize costs and maximize profits.
How to Invest Using Dollar-Cost Averaging
Nowadays, advanced technology makes investing like dollar-cost averaging more accessible to investors. Banks, brokerages, and mutual fund companies provide tailor-made apps and website platforms, making investment management more accessible and more convenient. Before doing this, you should follow some steps to ensure a well-executed investment plan.
Step One: Set up an investment account
For a DCA to work, you should research account types best suit your investment goals. Several vital criteria in your study should include investment costs, any automatic DCA plans, choice of investments such as stocks and funds, and finally, whether it is user-friendly. Lack of any of those may hinder your investment progress.
Step Two: Choose one or more investment types
Appropriate investment tools help you achieve your goals. Stocks are high performers but risky; most bonds are safe but lackluster performance. Mutual funds or exchange-traded funds are good choices if you are not familiar with investment types or have no time for research. A mutual fund is a pool holding many stocks and can also diversify some investment risks. An exchange-traded fund has lower costs and invests from securities from an index.
Besides, investors should research types of investment markets. DCA may not contribute but even harm your portfolio performance if you invest in a market likely going down for several years or longer. You should talk to your financial advisor before making decisions.
Step Three: Choose a budget for investing
It seems a no-brain decision. Yet you must realize it is money to be put aside to consume in the future. To use it before the schedule may jeopardize your plan and goals. Moreover, consistent investing without disruptions requires a determination to succeed in executing your plan. Therefore, your investment sum is for a long-term purpose only, whether it is a source from a lump sum or regular income.
Step Four: Execute DCA
The last step is setting up an automatic or manual DCA. An automatic DCA saves your time and effort in managing your investment plan. However, if you invest irregularly in terms of amounts and frequency, a manual plan may be more appropriate to monitor your portfolio.
Conclusion
Dollar-cost averaging investing is an effective strategy to reduce risks without closely monitoring your portfolio. Still, you should stick to your investment plan and perform regular checks on your investments to be on track towards your goals.
Key takeaways:
- Dollar-cost averaging investing reduces investment risks.
- Commitment and persistence are necessary for executing DCA investing.
- DCA investing can apply to stocks, mutual funds, and exchange-traded funds.
- Transaction and administration costs are higher than lump-sum investing.
- Regular reviews and monitoring are essential to keep your investment portfolio on track.
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