Before discussing the investment strategy, let’s assume you have to shift stone/s from one place to another. We give you the choice to shift one stone that weighs 100 kgs or 10 stones of 10 kgs each. Which one would you prefer? The second option is more practical and feasible. Lifting a stone of 100 kgs seems almost impossible that you won’t even try.
Similar situations take place among investors as well. A smart investor will take small confident steps over a long period of time. This is the recipe to accumulate wealth in the long term.
It is natural to feel overwhelmed while investing in the stock market, especially for beginners. Thanks to dollar-cost averaging, investing a pre-determined amount of dollars at regular intervals can help you grow your wealth over-time.
What is Dollar Cost Averaging?
In the Dollar-Cost Averaging strategy, a specific amount is invested at pre-determined intervals of time, in a particular investment option. This technique reduces volatility and builds wealth over a long period.
Here, you invest irrespective of the price of the asset or its performance and at regular intervals. Investopedia says that this strategy can overcome the bottleneck of timing your investments.
You can understand this better with an example. Suppose Johnny receives a paycheck of $2,000 every fortnight and he decides to invest 10% in his employer’s plan. He chooses to contribute 60% of his funds into an ETF and the rest of it towards a mutual fund. So, after every 2 weeks, 10% of Johnny’s paycheck will go into these accounts regardless of their price.
Dollar Cost Averaging will fetch lesser units when the stock markets are performing well and vice-versa during a bear run. As a result, it averages your cost of buying a share or mutual fund over the long term.
Advantages of Dollar-Cost Averaging Investment
Dollar cost averaging has its own pros and cons.
This strategy is suitable for almost anyone willing to invest — especially for people who don’t have the time and energy to contribute towards investing.
The fixed investment amount and investing timeline eliminates that need to sit and time the market. It also makes it easy to invest during phases of high volatility.
Another benefit of dollar-cost averaging is that investors can earn average returns on their investments over the long term. It removes the need to worry about getting the best price out of an investment.
Investing a certain amount of money is convenient, as you don’t need to have a huge corpus upfront. People with monthly income can easily take advantage of this strategy and build wealth to fulfill their goals.
Investing is more of a mind game than a numbers game. When considering any investment decision there are high chances of bias. Dollar-Cost Averaging reduces the emotional aspects of investments.
Dollar-cost averaging is a smart and convenient investing strategy, as you don’t need a lot of money to invest. It averages out your investment cost over the long term.