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What is Dollar Cost Averaging (DCA)?
Dollar cost averaging is a strategy where you regularly invests a fixed amount of money into a particular investment, regardless of the price.
Example?
If you want to invest $10,000 in a particular stock. Instead of investing all the money at once, you decide to invest $1,000 per month for 10 months using dollar cost averaging.
- First month: The stock is priced at $50, you buy 20 shares ($1,000/$50)
- Second month: The stock price has dropped to $40, you buy 25 shares ($1,000/$40)
- Third month: The stock price has increased to $60, you buy 16.67 shares ($1,000/$60)
- and so on....
At the end of the 10 months, assuming you will have bought a total of 100 shares and spent $10,000. The average cost per share you will have paid will be ($10,000/100)= $100 per share.
As you can see, by investing the same amount of money every month, you are buying more shares when the price is low and fewer shares when the price is high. It has an averaging effect on the cost of the shares over time.
What's good about this?
Well, by consistently investing the same amount, you can buy more shares when the price is low and fewer shares when the price is high, which can average out the overall cost of the investment over time. This reduces the impact of volatility on the overall purchase.
Additionally, dollar cost averaging can help to remove the emotional component of investing, i.e. following through this strategy with good discipline will avoid the timing / prediction of market movement.
The above is just one method and there can be variations from it. Please note that it isn't financial advice. Thank you for reading!
