The S&P 500i recently hit a record high. But while many investors feel overjoyed when they see their portfolios grow, others among us are waiting for the other shoe to drop. If you‚Äôre in that latter group, consider Dollar-Cost Averaging (DCA)ii as a way to manage market risk.
DCA is more than airline code for Washington, DC‚Äôs busiest airport. By definition, DCA involves investing the same amount of money at regular intervals, regardless of a stock‚Äôs share price. For example, an investor could purchase $300 worth of a stock or bond every month for a year. In a nutshell, DCA lets an individual invest without worrying about short-term volatility or trying to time the market.
Why It‚Äôs Important
As you might know, it‚Äôs nearly impossible to predict short-term spikes and dips in the market or individual stock prices. Rather than accidentally investing a lump sum when the market is high, you can manage risk by investing less, consistently. In this way, DCA allows you to effectively pay the average share price over the time period. This approach can also reduce buyer‚Äôs remorse if the investment price drops right after purchase.
Another advantage DCA offers to investors is its affordability. Most of us work for a living and get paychecks at regular intervals. DCA lets you invest a portion of your paycheck instead of saving up a larger lump sum. While some studies have shown that the lump-sum approach can offer better performance under some conditions, DCA does well when the market is volatile or falling, and tends to outperform over longer timeframes. Remember, no one can predict exactly when the market will rise or fall.
It‚Äôs also always a good idea to invest money when you have it. This is because over time the market tends to rise. Today‚Äôs price is likely to be lower than a year or two from now, even with dips along the way. Therefore, the opportunity cost of waiting and doing nothing is expensive, and it‚Äôs difficult to time the market and try to purchase at the absolute bottom. So, put your money to work as soon as possible. As one of my favorite investment writers, Nick Maggiulli, likes to say:
Sometimes I hear about friends who save up cash to ‚Äúbuy the dip‚Äù when they would be far better off if they just kept buying.¬† My friends do not realize that their beloved dip may never come.¬† And while they wait, they can miss out on months (or more) of continued compound growth.¬† Because if God can‚Äôt beat dollar cost averaging, what chance do you have?
How You Can Take Advantage of DCA
To use DCA, it‚Äôs best to invest with a firm that allows you to set up automated contributions. That way you‚Äôll always ‚Äòpay yourself first‚Äô and truly average out your purchasing. More importantly, your money needs to be invested immediately, not just kept as cash until the next rebalance. Otherwise, you aren‚Äôt really taking advantage of DCA. Emperor Investments is a firm that can help you create an automated contribution plan and invests your money immediately. You can learn more and get a 6 month free trial here.
At the end of the day, DCA takes the emotions out of investing and can potentially save you money through buying into your investments at their average price over time. ¬†But it really all depends on your investment philosophy. If your goal is to minimize investment regret, reduce portfolio volatility, and sleep well at night, the research suggests that dollar-cost averaging is a good approach. It‚Äôs up to you to choose the investment approach that best aligns with your goals and psychology. But the most important thing is to stay the course.
i – The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.¬† It is a market value weighted index with each stock’s weight in the index proportionate to its market value. Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred.¬† Returns do not include reinvested dividends.
ii – Dollar cost averaging may help reduce per share cost through continuous investment in securities regardless of fluctuating prices and does not guarantee profitability nor can it protect from loss in a declining market.¬† The investor should consider his/her ability to continue investing through periods of low price levels.
Investment advisory services offered through Emperor Investments, a registered investment advisor.