Protect yourself against market fluctuations with this simple, yet effective long-term investment option: dollar cost averaging. Buy a fixed amount of stock on a regular schedule to eliminate the need to try and figure out the best time to buy.
Take a Systematic Approach to Investing With Dollar Cost Averaging
Yes, dollar cost averaging does mean that you will buy some stocks when they are high. But, you will also be buying some stocks when they are low. The philosophy here is to buy smaller amounts of stock at a time, over regular intervals. This systematic approach to purchases will allow you to buy at an “average,” making the entire process less taxing on the nerves.
According to the experts at NerdWallet “your focus is on accumulating assets on a regular basis, instead of trying to time the market.” This can be a wonderful strategy for skittish investors, allowing them to experience more success and bigger profits over the long haul.
What Happens When the Market Falls?
When the market hits a downturn (and it always does), traditional investors tend to sell off shares that are losing ground and look for better deals. This strategy is the exact opposite when compared to dollar cost averaging. When you employ a dollar cost averaging investment strategy, you don’t look at market downturns as something to worry about, but rather, an opportunity for growth. When prices are down, your set investment amount will buy more.
Let’s compare the two investment philosophies:
In a standard stock buy, you may purchase $10,000 worth of stock at $100 per share all at once. If the stock price slides to $70 a share, you’ll lose 30% or $30,000.
Now, let’s say you take that $10,000 and purchase the same stocks over a one-year period. Over time, the stock price fluctuates (some will cost $100 a share; some $70 a share; and a few for prices in between). That means that the “average” cost of your shares will be lower than they would have been if purchased all at once. This results in higher buying power.
When you use a dollar cost averaging approach to buying stock, you spend the same amount of money during a given calendar year, but you often end up owning more individual stock.
Now, when the price of the shares goes up, you will have more shares in your portfolio to work with.
Who Benefits the Most From Dollar Cost Averaging?
The dollar cost averaging approach is not for everyone. But it is a solid investment strategy for those with a low-risk tolerance and who have the time to wait out market fluctuations.
While it is never a good idea to hold onto stocks that continue to spiral downward, adopting a strategy that allows for long-term risk – and growth - can result in big profits.
The key to success here is being willing to invest a certain amount of money monthly or quarterly into the same stocks to allow you the ability to experience both the highs and lows in prices. It does not have to be a lot. Many brokers will allow smaller investors to start with as little as $50 per month. Over time, dollar cost averaging will allow most investors to accumulate enough stocks at an “average’ price to bring in a decent sized profit without the constant strain and worry about what the market is doing on a day-to-day basis.