What Is Dollar-Cost Averaging?
Timing the market, especially post-COVID, is difficult for even the most seasoned investors. However, the closer you are to retirement, the less time you’ll have to recover from money mistakes. Whether you are in the early stages of growing wealth or are beginning to wind down the accumulation facet of your financial life, dollar-cost averaging (DCA) may be beneficial.
A tried and true strategy for growing your nest egg, dollar-cost averaging can make safeguarding your money in uncertain markets easier by creating automatic, consistent investments.
With a DCA approach, you invest the same amount of money into a target asset over a specific time, regardless of the price of that asset. Dollar-cost averaging potentially reduces volatility’s impact and lowers your average cost per share. You’ll regularly buy in both up and down markets and purchase more shares at lower prices and fewer at high prices. This strategy could help you avoid a badly-timed lump sum investment where you overpay for an asset. An example of dollar-cost averaging over a long time horizon are 401k or other qualified plans. Participants in these plans regularly invest, regardless of whether fund prices are going up or down.
Many choose dollar-cost averaging to lower the amount of money they spend on investments or enforce the discipline of regular investment.
You might also prefer DCA to remove the perils of market timing and remove some of the emotion involved in money decisions.
Who can benefit from dollar cost averaging?
DCA may be an excellent way for beginning investors to get started. It can also be a helpful strategy for those who do not have large sums to invest at once. If that’s the case, waiting could cause you to miss out on potential gains. DCA can help get smaller amounts of your money into assets consistently. If you use a dollar-cost approach, you’ll be able to take advantage of a rising market without waiting until you have thousands of dollars saved.
Also, if you are risk-sensitive, dollar-cost averaging may give you more confidence about investing during downturns. Research supports the idea that people who stay invested during bear markets have often fared better than those who pull out their money and attempt to time the next upswing.
Are there any downsides to DCA?
Some financial researchers say that dollar cost averaging over a very long period tends to underperform lump sum investing. Many planners suggest that their clients with more considerable lump sums of cash benefit more from investing that money as soon as possible.
It’s impossible to predict a market’s ups and downs accurately, so using DCA could give you the solid returns you desire while buffering your savings against risk. However, you shouldn’t rely entirely on research. Speak with your advisor and do your due diligence. You may find that your unique situation, goals, and risk tolerance warrants a more cautious, consistent investment methodology such as dollar-cost averaging. After all, dollar cost averaging can still help grow your wealth reliably, provide psychological benefits, and mitigate the effects of lost opportunity costs.
Summing it up:
Dollar-cost averaging may be used by anyone looking for potentially lower average costs, automatic, consistent investing, and less pressure to make money decisions during a volatile market. Dollar-cost averaging isn’t a fit for everyone. However, it could be a valuable tool at any stage of a person’s financial life, especially if they are beginning investors or are less risk tolerant.
When looking into DCA, it’s critical to consult an experienced financial advisor or retirement income specialist. When deciding if dollar-cost averaging works for you, your advisor will consider several factors, such as your outlook for investments and the broader market.
