How Does Dollar Cost Averaging Work?

We all know that investments come with risks.

But certain strategies, like, for example, dollar cost averaging, claim to help lower the overall amount you pay for investments and minimize the risk factors.

But does it really work?

With dollar cost averaging, investors buy in small amounts of shares at regular intervals no matter the price, instead of buying up one larger share all at once.

The idea with this strategy is that even though some days these small investments will come at higher price points, the overall average cost over the long term will be lower than what you would otherwise pay- and this strategy will help boost your returns.

In this article, we will take a look at how dollar cost averaging works, how this strategy differs from market timing, and why this strategy is particularly good for first time investors.

Fractional shares is another way to buy portion shares of a company stock.

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Understanding Dollar Cost Averaging

As stated above, dollar cost averaging is a strategy for investors to minimize the price risks of buying stocks, mutual funds, or exchange-traded funds (ETFs).

Rather than acquiring shares of one particular security in a large amount all at once, at one single purchase price, you will instead divide up the total amount of money you would like to invest.

Then you will make many small investments at regular intervals of time over a long period.

Employing this strategy, you decrease your risk of investing a huge amount right before the market prices drop.

You also improve your chances of paying a lower average price overall, even as market prices rise.

With dollar cost averaging your money gets put to good use on an ongoing basis, leading to long term growth in your overall investment portfolio.

You can think of dollar cost averaging as the “slow and steady wins the race” style of investment.

Investing smaller quantities at regularly timed intervals allows you to avoid the lure of emotional investments or impulse sales. 

How Is Dollar Cost Averaging Different From Market Timing

The dollar cost averaging strategy works in part because asset prices have a tendency to increase over long periods of time.

But in the short term, they tend to run up to high highs and low lows in an inconsistent and hard to predict fashion.

This makes the risk of buying a large quantity of shares at the wrong time more potent than spreading out the smaller purchases over many investments. 

While it may sound like a more straightforward strategy to simply “time” the market and invest a huge amount in assets while prices are low, this is not actually the case.

In fact, it is nearly impossible, even for professional investors and analysts, to tell which way the prices will swing in the short term.

What looks like a low price today could in fact become a pretty high price by next week, while what looks high today could seem quite low in just a month. 

Trying to keep tabs on this constant up and down and the dynamic shifts of value in the market on any specific asset can cost you in the long run.

Most investors who attempt to outsmart the market and wait to invest it all when the price is right end up earning significantly less than those who invest regularly and consistently with dollar cost averaging. 

Also Read: Amazing Habits of Highly Successful Investors

Why Dollar Cost Averaging Is Good For First-Time Investors

For first time investors, dollar cost averaging is a great strategy for a few reasons.

First off, it requires much less research into what the market is doing and precisely when and where you should invest.

For first time investors it can be intimidating and a waste of time to spend days researching market statistics.

Instead, choose the asset you would like to invest in, and then let your portfolio invest the same amount each month.

The Wealthface online investing platform makes investing easy- you can easily keep track of your entire investment portfolio at any time right on your phone, but you don’t have to put in extra effort after that first initial investment. 

Another reason dollar cost averaging is a smart choice for investors just starting out is that this strategy works even if you are investing with a small amount of money.

This makes it a practical choice for those who want to maximize on a minimal investment.

Since it doesn’t require a large sum to invest all at once, you can spend a certain percentage of your monthly income on investing.

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So smaller amounts of your money are regularly going into the market, without you having to wait to amass a significant investment fund.

In addition, dollar cost averaging helps new investors even when the market is down.

Rather than stopping your investment process or withdrawing the investments you have already made, dollar cost averaging ensures that you will keep on persevering even through market dips.

That way you will never miss out on the period of market growth down the line.

Most people who withdraw their funds during low markets and attempt to time their re-entry to maximize profits end up missing out on gains in the long term. 

Final Thoughts

Dollar cost averaging is good for people who are just beginning to invest and don’t have huge amounts of money with which to buy shares.

It is also the best option for people who want to avoid spending tons of time on research.

Platforms like Wealthface are the perfect solution for first time investors who are ready to invest with as little hassle as possible. 

With Wealthface, first time investors can rely on an extensive set of easy to navigate tools and virtual assistance that allow you to see where, how, and when to invest.

You can also keep track of all your different types of investments in one place, right on your smartphone.