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Many would-be investors wish there was a simple way to start structuring their investments and planning for investment in their budget. I’ve been using a strategy known as dollar cost averaging for years now, but I’m always surprised to learn that many investors don’t know what it means. If you want to lower your average cost per share and want to contribute a set amount toward a portfolio every month, this is what you need to know.
Dollar cost averaging means that an investor contributes a set amount of funds to a portfolio each month, regardless of the fluctuation in share price. This gives a lower average cost per share, offers lower risk, and makes it easier to automate savings.
For everything you need to know about dollar cost averaging, here is our definition and how it applies to the three main investment vehicles you might have in your portfolio.
Dollar Cost Averaging – What Is It?
Investors who are trying to think ahead may want to consider how dollar cost averaging impacts a portfolio. While it may sound a little bit technical, this investment strategy is actually fairly easy to understand and implement.
Dollar cost averaging simply means that you invest a fixed amount of money into your portfolio at regular intervals (typically monthly).
This is a great way to work investing into your monthly budget. Spend a few hours with the details of your financial plan and see how much you can afford to contribute to an investment portfolio.
Then, all you need to do is simply take those funds and allocate them to your investment.
How does it really work?
For example, after taking a look at your budget, you found that you could contribute $250 to investing at the end of each month. You’ll take that money and invest it into whatever vehicle you choose.
Some months, you may be able to purchase several shares of a company with your $250. Other months, it may only be a few.
It really just depends on what the price is for the asset you want to invest in.
If the prices are low, then you might get a great bargain for your $250 this month. On the other hand, higher prices mean that you won’t be able to buy as much with that same $250.
Inevitably, what you can buy will vary, meaning, your goal should be to buy what you can with what you have, and not, to buy a certain number of shares or properties every month.
This is where dollar cost averaging comes into the picture.
Because you are now looking at the average of what you were able to purchase, most investors find that they had a lower average cost per share than if they had purchased all of their stocks at one of the highest investment points.
In other words, dollar cost averaging is an easy way to invest and even to save money on the cost of those investments while you build wealth.
Using Dollar Cost Averaging For Stock Investing
The stock market is usually the first thing people tend to think of when it comes to dollar cost averaging, because the stock market of today is super accessible for anyone with the help of free apps like M1 Finance or Robinhood.
It’s a simple way to make a big impact on your portfolio, and most investors come out ahead with this strategy. Dollar cost averaging works in a few different ways when it comes to stocks.
1. It Encourages You To Continue Investing For The Long-term
You’ll have a plan in place for how you want to go about investing funds into the stock market.
This develops a sense of self-discipline, making it more likely that you will continue to contribute to your portfolio.
2. It Takes The Emotion Out Of Your Investment Strategy
If you know where you want to put your dollars (let’s say in a stock like Amazon or Walmart), you will continue to put your dollars in those stocks month after month – even if you notice a small decline.
Because you have a plan in place, you are much less likely to sell all of your assets or to change course just because you see that your investments had a bad week.
3. You Are Likely To Get A Better Average Stock Price
Think of it this way: imagine you contribute $1,000 upfront to your investments and the average share price was $10. This means you were able to purchase 100 shares.
Instead, you might contribute $200 every month for five months. One month, shares were $10 but the next month they dropped to $8. The month after that, they dropped to $6 before jumping back up again to $10 for the remaining two months.
For the same $1,000, you would be able to buy 118 shares instead.
This takes your average cost from $10 per share to $8.47 per share instead. The math certainly works in your favor.
If you’re ready to start buying more shares at better prices, consider signing up with M1 Finance or SoFi for commission-free trades that keep even more money in your pocket.
Remember that you can also reinvest dividends to help your portfolio grow even faster. This will lead to compound interest which makes a great impact over time.
How Dollar Cost Averaging Works For REITs
Oftentimes, dollar cost averaging gives you more buying power in the stock market. The math might be a little more complex for REITs, but it still holds tremendous value.
Let’s take a closer look at how you can maximize your investments with dollar cost averaging and REITs.
The first thing you’re going to do is decide how much money you can afford to invest in REITs each month. Consider using a platform like Fundrise to make your investments easier.
This allows you to get started with minimal amounts as low as $10 or as high as you would like to go. Fundrise is a flexible platform that makes getting started in real estate more affordable.
But, let’s suppose that you are able to contribute $100 to your Fundrise account monthly. During the first month, your shares of the REIT were priced at $25 per share. This means that you were able to purchase 4 shares.
Then, something interesting happens. The fund pays out its first dividend and the price of the shares starts to drop. You get in on the trend just in time with a new $100 infusion of cash into your account.
Now that the shares are priced at just $20, you’re able to buy 5 shares – bringing your new total to 9 shares.
Much like investing in the stock market, you can see how you would be able to lower your average cost per share.
Between the first two months, your average cost per share was just $22.22 instead of the $25 it would have been if you had invested all $200 upfront.
Reinvesting REIT Dividends
Of course, there is something else to consider when it comes to your REIT investments: dividends.
REIT dividends are the money that investment platforms like Fundrise pay to shareholders from rental income and capital gains.
While you can certainly take these dividends as a form of passive income, you could also reinvest them and do even better with your dollar cost averaging.
Go back to our previous example. Let’s say that you still purchased 4 shares at $25 each. Then, that REIT paid out a dividend of $100 which subsequently dropped the price of the shares to just $20.
If you reinvested that dividend plus your next $100 investment, you would now have a total of 14 shares.
This means that you originally invested only $200 but were able to purchase 14 shares, dropping the average cost per share to $14.29.
As you can see, there are a lot of positive things to be said about reinvesting REIT dividends. It gives you more purchase power that you can then turn around and use to buy more shares.
Since this wasn’t necessarily money that you were counting on in your monthly budget, reinvesting the funds into your portfolio helps it to grow faster.
Making Better Crypto Investments With Dollar Cost Averaging
Now, it’s time to turn our attention to another popular investment vehicle that can also benefit from dollar cost averaging: cryptocurrency. In essence, it works much the same way that dollar cost averaging works for the stock market and REITs.
You still set aside a given amount of money to invest each month and stick to it to generate long-term gains.
The catch is that crypto tends to be a lot more volatile than other investment strategies.
If you’re investing in cryptocurrency on a platform like BlockFi, here is what you need to know in order to make the most of dollar cost averaging.
For this type of investment, you might make out better by watching the subtle (or sometimes dramatic) fluctuations in the market. Buying when prices dip can help you to really get ahead.
On the other hand, watching those volatile markets swing wildly can leave you feeling a little seasick and can lead to emotional decisions to buy and sell.
Instead, dollar cost averaging proposes that you should instead contribute your set amount into your BlockFi account and make your purchase, regardless of what the market looks like.
Sometimes, you may end up purchasing crypto at a higher price. This is often balanced out when some months present lower prices.
Much like stocks and REITs, you will find a lower cost average for your investments when you stop to do the math.
The benefit of this method is that you may avoid some of the volatility of the crypto market, make regular contributions, and have a safer experience.
You might not earn as much through dollar cost averaging as you would through timing the market just right, but it is also a lower risk to your portfolio.
The rewards are lower, but so are the stakes.
Keep in mind that you may pay a transaction fee on each deposit you make into a crypto market – check out our full BlockFi review here.
Other marketplaces may charge a set transaction fee each time you contribute. That means that these platforms will charge you five times more for making six contributions than they would for making a single lump sum transaction.
Be sure to do your homework on which marketplace you plan to use if dollar cost averaging is the strategy that makes the most sense for you.
You don’t want your savings and earnings to be eaten away by hefty fees for making your monthly transaction.
Putting It Into Practice
Dollar cost averaging is a great tool for investors to use if they are concerned about how the ups and downs of the market will impact their portfolio.
You will inevitably be able to purchase some shares (whether in the stock market, a REIT, or as crypto) at a lower price than in other months. Sometimes, it can’t be avoided that you will pay a higher premium for those investments.
The good news is that your investments typically even out, giving you a lower cost overall when you factor in everything in your portfolio.
You may not see this phenomenon in the first two to three months, but take note of it over the course of a year. You’ll be surprised to see how it all adds up.
The most important thing you can do now is to take a hard look at your budget and see where you can trim expenses to have more to contribute to your investment strategy.
All you have to do is have a set amount of money that you contribute each month. In many cases, you can even automate that sum so that it drafts automatically from your bank account.
If you are ready to start putting dollar cost averaging into practice, it’s time to start refining your investment strategy.