Dollar-cost averaging is an investment strategy where you invest a set amount of money in stocks or assets at regular intervals, regardless of the current market conditions. A consistent approach such as this can, over time, help reduce the effects of the market’s peaks and troughs and lower the average price you pay for assets.
Keep reading to find out more details on how this works and the benefits of dollar-cost averaging and how STARTrading can support beginner investors with online trading courses.
What Is Dollar-Cost Averaging?
Dollar-cost averaging (DCA) is where you invest a certain amount of money to buy assets over regular intervals.
You do this regardless of the market fluctuations or asset prices. Although you will buy fewer shares when the price is high and more shares when the price is low, your investment amount will remain the same. This typically results in a lower average cost per share over time. For example, every month you could invest £100. In some months, you may receive more shares than others due to market fluctuations, but the amount which you invest will always remain constant, despite the number of shares you receive.
In essence, dollar cost averaging helps to:
- Lower your average cost per share
- Reduce the impact of market volatility
- Mitigates the risk of investing a large sum of money at an inopportune time
What Are The Benefits Of Monthly Contributions For Dollar-Cost Averaging?
Although it is never guaranteed, DCA can have some significant benefits for those who wish to make investments over a long period of time.
Combat Market Volatility
When you invest a consistent amount of money over time, this can mitigate the impact of market volatility and reduce your overall risk of investment.
Dollar cost averaging allows you to see through the highs and lows of the market and ultimately results in a lower average cost per share.
Disciplined Investing Habits
When you use DCA as an investment strategy, you are sticking to a predetermined investment plan. This, in turn, can result in disciplined investing habits as you are no longer making emotional decisions based on the short-term market and share fluctuations.
Having strong discipline when it comes to investing can help you in the long run, not just with DCA.
Prevents You From Chasing “Hot Stocks”
Hot stocks are shares that are currently experiencing high demand and high trading volume. These can be very tempting to chase after and focus on when you are investing. However, this way of thinking creates more risk to your investment portfolio and can cause stress when the stocks drop.
Sticking to a dollar cost averaging strategy can reduce the risk of being tempted to chase hot stocks.
You’ll Be Open To Opportunities
It’s easy to panic sell when your investment drops, but it’s harder to estimate the peaks and troughs of the market. However, dollar-cost averaging helps you to stay available when opportunities arise. For example, you might be tempted to withdraw your money when the stocks begin to fall, but in the coming months, when the stocks once again rise, you might regret your decision.
Sticking to a dollar cost averaging strategy will keep you open to these types of opportunities that you might not have come across if you were investing your money the traditional way.
Peace Of Mind
As DCA can remove the need to time the market or make speculative bets, you’ll be able to focus on your long-term financial goals while letting your consistent investing work away in the background.
What Are Some Downsides Of Dollar-Cost Averaging?
While using a dollar-cost averaging strategy does have its benefits, there are a few downsides to consider, too.
Market timing
Although not having to attempt to time the market correctly is an advantage, there are also some downsides to letting dollar-cost averaging do the work for you. Using the DCA strategy, you may miss out on potential opportunities to buy assets at lower prices or be able to sell them at a higher price. This can lower the value of your investment.
Market Conditions
A dollar-cost averaging strategy may be less effective in certain market conditions. Conditions such as a prolonged bear market or asset classes with low liquidity can be a disadvantage when using the DCA method. You should consider whether the dollar cost averaging strategy is suitable for your investment objectives, and try to understand your own risk tolerance before making a decision.
Transaction Fees
Fees and transaction costs can result in your returns becoming lower than expected. In some cases, platforms can have high transaction fees, which can make investing over a long period of time less viable. You should consider low-cost options where possible and be mindful of the costs associated with your investments.
Economic And Market Risks
Dollar-cost averaging is just like any other investment strategy when it comes to economic and market risks. Inflation rates, interest rate fluctuations, and regulatory changes are all factors that can affect your investment. You should make yourself aware of these risks first and be prepared to diversify your investment portfolio.
Is Dollar Cost Averaging a Good Idea For Beginners?
The dollar-cost averaging strategy can be a good place to start if you are a beginner and do not have a lump sum to invest all in one go.
If, every month, you are investing in a savings plan or a pension, you are already partaking in the DCA method. However, when it comes to investing in stocks and assets, you need to invest in the right diversified portfolio that matches your objectives and risk tolerance.
Dollar cost averaging can also be a good strategy for those who have a low risk tolerance. Yes, there will always be a risk, just like with any investment, but you may find it easier to swallow if you haven’t invested all your money at once. Drip-feeding, like the DCA strategy, can help you develop a behavioural strategy to accept the volatility of the market over time.
How Often Should You Invest With DCA?
Different investors will opt for different frequencies in their investments. Some may choose to invest daily, while others choose monthly. It all depends on which is best for you and your money, and how comfortable you are.
Daily DCA Investing
Investing daily may seem like a lot, but you can keep a close eye on the markets much better, helping you to be in the know about developments in market prices and trends. You’ll capture every rise and fall of the stocks, meaning that you will purchase when there are dips, but you’ll also be buying on the rallies.
Weekly DCA Investing
Weekly DCA investing gives you the opportunity to keep an eye on the market, but not have to check it daily. Meaning that you may spot opportunities to invest that could be missed with monthly investing. This can be a good option for people who want to be more involved with the investment but don’t want to run the risk of becoming too attached.
If you opt for weekly investing over monthly, you will want to consider your salary date, but also the possible transfer fees of moving that money. Bank transfers are usually free, but sometimes charges are incurred depending on the bank you use and where you invest your money. A downside such as this might make monthly investing more desirable.
Monthly DCA Investing
This is typically the most common method of investing with the dollar cost averaging method, especially for beginners or investors who don’t have a large sum of money. It is also a more laid-back approach to daily and weekly investing, as you don’t need to keep an eye on market volatility as often.
One of the main drawbacks to monthly investing is that you might miss some market opportunities by the time you have made your monthly deposit.
Is Dollar-Cost Averaging A Good Idea?
The answer isn’t as simple as yes or no. Whether dollar-cost averaging is a good idea depends solely on the investor, their money, and their risk tolerance. The dollar cost averaging strategy can safeguard you against losses in extreme market downfalls, but it can also hinder your portfolio growth in other markets.
In short, dollar-cost averaging can:
- Be a good starting point for beginners or investors with a smaller amount of money
- Allow you to spread out your investment so there’s no need to spend a lump sum of money
- Make it easier for you to manage your investment
- Create a good average buy-in price
How STARTrading Can Help with Dollar Cost Averaging
If you’re interested in trading and investments, STARTrading can help you begin your journey. We help our mentees achieve their life goals and use trading as the vehicle to make that happen. We are industry experts in providing training courses for beginners, and will help you to learn in a realistic but short time frame, so you can get real trading results from using as little as 30 minutes a day.
Take a look at our swing trading events for beginners, where you can learn how to trade confidently and safely, or contact us with any questions or support you may need.
