29 July 2020
Investing is much more than just using your capital wisely. The risk of losing money is always around the corner. Many techniques can allow you to analyze market prices from different perspectives. You may also want to develop a sound investment strategy.
Dollar-cost averaging (DCA) is a perfect place to start.
What is DCA?
Dollar-cost averaging, also known as the constant dollar plan, is an investment strategy. This strategy reduces the impact of volatility on the purchases of financial assets. This prevents making a one-time investment.
The investor divides their total amount into equal parts. It is invested at regular intervals of time. DCA gives control of the investment to the investor. It also mitigates the impact of market fluctuation.
How Does DCA Work?
Let’s put it into an example: you have been saving part of your salary for 5 years and have built capital. You want to buy shares in the stock market and have a total amount of US$ 500,000. Instead of investing all the capital in one purchase, you divide the capital into amounts of $25,000. After that, you buy shares on a regular schedule for the next six months. If stock shares’ prices drop, you will able to buy more shares – if prices rise, you will buy less.
If you are disciplined enough, this will allow you to buy what you want at an average cost, therefore limiting potential overall losses.
The market is unpredictable, and the fear of losing money can grow with uncertainty. This strategy can be a lifesaver in the case of a drastic price drop. It also saves you the work of timing the market to visualize the best time to buy.
Pros and cons of DCA
Strategies are personal decisions about how we want to manage situations. Even a veteran investor can find some obstacles in their path. Things can get complicated if we are not careful about our decisions.
DCA could be the best plan for rookie investors, but like any other strategy, it has its pros and cons.
- This strategy can help the investor to save money in the long-term. Dollar-cost averaging helps you set a goal and build your investment portfolio.
- Dollar-cost averaging takes into account the emotional factor in our investment decisions. Market fluctuations and losing money put huge pressure on investor’s shoulders. DCA minimizes the impact of emotions on your investment decisions. You have control over your investment schedule and how much you want to invest.
- This strategy can be useful in the crypto market. Dramatic drops won’t affect you as much as a single investment would.
- Can you imagine investing small amounts of money for the next 100 years? The problem with DCA is that the results take time to appear. Although prices fluctuate, stocks tend to increase over time. It means that, on average, you would buy fewer shares, and it would be a long-term loss if the market is not well studied.
- Some investors argue that with DCA, some of the potential gains are lost. This is because you might not invest at the right time to have certain returns.
There is no such thing as a magic formula for a perfect investment. If you are just starting, you need to keep this in mind. The strategies you will use will depend on your situation and the goals you have set.
If you find trading complicated but still want to invest, DCA might be the right tool for you.