What Is Dollar-Cost Averaging? Everything You Need To Know

Have you always wanted to invest with dollar-cost averaging but you don’t know how?

Dollar-Cost Averaging is a strategy you should integrate while trading. It helps reduce risk on four investments and protect them from volatility.

While you may be having doubts about the effectiveness of dollar-cost averaging, this article will explain what it means and its benefits to you as an investor.

What Is Dollar-Cost Averaging?

Dollar-Cost Averaging is an overall trading strategy that allows you to buy any asset regularly during the buying and holding period. It reduces risk and the effect of volatility. When performed appropriately, it can have a positive impact on your portfolio.

Dollar-cost averaging primarily helps improve your returns because a large quantity of shares is bought when prices are low and less when prices are high. It also prevents wrong lump-sum investment, and so, it augments investor utility.

How Is Dollar-Cost Averaging Calculated?

A lot of experts have compared DCA to other available buying strategies in an attempt to understand its benefits. DCA is calculated in four ways; during a lump-sum purchase, falling market, flattish markets, and rising markets.

DCA thrives during a falling market and also operates in a flattish market even when there are only a few ups and downs. However, its performance is weak for short-term periods during the rising market. While the stock is increasing in value and price, you won’t be able to maximize your gain.

DCA helps revert risk when you invest a certain amount of dollars into risky assets at a regular interval. To benefit you as an investor, it is important to avoid an ill-timed lump sum investment. It pays more when you buy more shares at low prices and lesser shares at high prices.

Is DCA Effective?

Yes, it is. It has significant benefits for you as an investor and for your portfolio.

Although lump-sum purchase affects it, DCA does have a profitable return. It will help you avoid wrong calculations of the market and also help you to make rational decisions and think long-term.

Why Should You Invest Using Dollar-Cost Averaging?

DCA may seem like a perfect trading strategy but for it to produce positive results, the time for investment should ideally be between 6–12 months.

Reasons to invest in DCA

It Shapes Your Trading Decision

One of the major benefits of dollar-cost averaging is that it helps you make rational decisions by reducing the influence of volatility and market timing on your portfolio. Staying committed to DCA guides investors away from making counter-productive decisions due to fear.

Some of these counter-productive decisions include; buying more assets when the prices are rising and selling them when prices start to decline due to fear.

Instead, DCA ensures that as an investor, you continue focusing on investing a certain amount of money each period while ignoring the price of each purchase.

It helps to average out share price instabilities

DCA helps average out share-price instabilities. Price fluctuations are not uncommon in a highly volatile market, but dollar-cost averaging will help decrease the price you pay with every share. Since you will be buying more shares when prices are low, what you will be paying is lower than the average share price.

In essence, its advantage is that it removes sentimental elements from investing. Since you will be investing on a regular interval regardless if it is lump-sum, rising market, falling market, or flat market, sentiments are removed from your trading decision making process.

In DCA, you are thinking long-term, so selling your holdings due to a downswing market is not a good trading decision. If you consider a falling market as an opportunity to buy at low prices, you must bear in mind that this strategy is only effective if you are investing for the long term.

Risks Involved in Dollar-Cost Averaging

As stated earlier, DCA reverts risk but that doesn’t mean that it doesn’t have risk factors. While dollar-cost averaging allows you to buy more regularly, it adds to trading costs, but these costs are manageable as different exchange brokerages charge less for trading.

Since you aren’t trading in and out of the market, rather, you are investing for the long-term, then you won’t be affected; fees also get smaller compared to your entire portfolio.

Despite the all-around levels of risk prevention, DCA produces fewer annual returns and average utility. Experts have also identified other strategies that are better than DCA judging from the theoretical aspect and numerical simulation.

Starting investment using a dollar-cost strategy is effective, but it has its own limited risk as well.

Always bear in mind the risk that comes alongside investing and how much risk you’re willing to take. You should also be wary of market timing and always be careful not to allow your emotions to influence your trading decision.