How To Use Dollar-Cost Averaging To Build Wealth
June 8, 2021 (Investorideas.com Newswire)
What Is Dollar-Cost Averaging?
Dollar-cost averaging, or DCA, is how you systematically invest a certain amount on predetermined intervals to slowly build a position in an asset. For example, let's say you have $10,000 that you want to invest. Instead of investing $10,000 at once, you may choose to invest $1,000 every month, for 10 months. With this investment strategy, purchases will be made at frequent intervals regardless of the changes in stock price.
Dollar-cost averaging is done primarily to reduce the impact of volatility. Since stocks undergo price movements in the short term, you can reduce the average cost price if you buy the stocks at different times. Dollar-cost averaging is especially helpful in a bear market, as it allows you to buy stocks when the prices are lower.
For instance, if Morgan Stanley currently trades at $100, and instead of buying 100 shares of the stock at once, you decide to invest the same amount of $10,000 over a period of 10 months. So you buy the same stock when it is trading at $95, $90, $85, and $80. Instead of 100 shares, now you own 114 shares, and the average share price is $87.50. This way, dollar-cost averaging ensures that you're not buying stocks in a lump-sum investment when the stock price is at its peak.
Dollar-cost averaging works with all tradable securities but is mostly used when investing in exchange-traded funds (ETFs), index funds, and mutual funds.
How Does Dollar-Cost Averaging Help An Investor?
Dollar-cost averaging can help you to:
- Be consistent with your investments
- Avoid emotional investing
- Reduce market-timing attempts
- Achieve long-term growth
By taking a systematic approach, dollar-cost averaging helps you remain consistent with your investments. Markets tend to get highly volatile in the short term, and extreme price movements may tempt the investor to make emotion-driven decisions. When you dollar-cost average, you take emotions out of the equation, which allows you to buy stocks, regardless of how the market is performing.
Additionally, the use of dollar-cost averaging eliminates the possibility of futile attempts to time the market. This is important, as trying to time the market seems to be the number one reason why most investors lose money.
The downside of dollar-cost averaging is that mostly, there will be cash on the sidelines that isn't invested, and as a result-isn't generating returns.
With all these wrong investment practices in mind, did you know that 95% of investors have also been using Dollar-Cost Averaging wrong this entire time? Find out why on page 167 of our bestselling book: The 8-Step Beginner's Guide to Value Investing.
How To Incorporate DCA Into Your Investment Strategy
Most likely, you're already doing this with your 401(k)s at your workplace, especially if you're contributing a fixed amount from your paycheck regularly. You can do the same with your investment portfolio.
When it comes to implementing this strategy, you can do it in two ways: either by doing it yourself by manually taking a set amount of money from your paycheck and buying stocks, or you can set up automatic recurring deposits using your brokerage account. Most online brokerage companies allow you to set it up by yourself. You'll need to specify the amount you want to invest, how often you want to invest, and how long you plan to invest.
Dollar-cost averaging is a great way to build wealth over a long time. Through this, you'll be investing in stocks consistently regardless of the market scenario, which most investors fail to do most of the time. A dollar-cost averaging strategy will help you reduce your cost basis in an investment over time, avoid making emotional decisions, and generate substantial returns in the long run. Additionally, you can reinvest dividends, which compounds your returns.
The long-term success in all kinds of investments is the result of discipline, patience, and reliable companies. Remember, with any investment plan, success depends on the investor. So stay the course, be consistent, and start today in case you haven't started yet.
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