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What Is Dollar-Cost Averaging?

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by Gavin in Blog
May 31, 2020 0 comments

Dollar-cost averaging is an investment strategy that involves dividing up the desired investment capital into periodic purchases of a specific stock or security.

This is done as an attempt to reduce the impact of a volatile market on the overall purchase.

The periodic investment occurs at regular times throughout the year, such as every month, or sometimes even just once a year.

Investments occur regardless of the market value or stock price which removes any need to interpret the right time to purchase in your selected market.

This strategy is known for its long-term benefits rather than its short-term benefits.

Moreover, it allows an investor to neutralize short-term unpredictability in the wider market.

Dollar-cost averaging is widely used among 401(k) plans, and American’s retirement package.

Over the course of their employment regular investments are made without consultation of the current state of the market.

Another common use of this strategy is in dividend reinvestment plans – where an investor can choose a specified amount of dividend earnings to be reinvested back into the company.

Does Dollar Cost Averaging Work?

Does it actually work? This is a common question associated with dollar-cost averaging and the answer is yes, but you have to be patient.

The strategy provides three key benefits over many other short-term investment strategies. It can assist you in:

  • Not mistiming the market
  • Taking the emotion out of investing
  • Thinking of the long-term

Removing you of your unconscious biases is a key positive of dollar-cost averaging – no emotion is involved.

Advantages And Disadvantages Of Dollar Cost Averaging

It’s possible when you are dollar-cost-averaging that you will be purchasing when others are selling, scoring yourself a nice price – establishing the ability to earn serious long-term gains.

With all the upside potential comes a few disadvantages of utilizing dollar-cost-averaging as an investment strategy for your portfolio.

More trades equal higher trading costs as you are engaging in it more often, it is important to find a broker who charges a reasonable amount for their brokerage services.

Secondly, by investing over an extended period of time you may forgo huge potential profits if you were to invest in a lump sum and sell when the market is high.

Nevertheless, this is unlikely due to the likelihood of you timing the market correctly.

It is common knowledge that investors are usually terrible at predicting short term movement.

To start your dollar-cost averaging investment plan you will need to conduct research upfront to determine a stock in which you aim to purchase at regular intervals.

Speak to your broker and they will outline the formal process and regulations that may apply to you.

It is relatively easy to set up a payment plan with funds being taken out each month automatically to purchase your chosen equity.

Investments can be suspended if needed as you are not tied to an investment contract.

To get an extra bonus out of your doll-cost averaging investments you can ask your broker to automatically reinvest your dividends.

Although in the short-term it may not amount to a high degree of extra investment, in the long-term you may come out with a much higher yield due to it.

As with everything, consult a financial expert to see if this strategy is right for you.

Trade safe!

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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Options Trading 101 - The Ultimate Beginners Guide To Options

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