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What You Need to Understand About Dollar Cost Averaging

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Alina Ren Article 1

Investing can seem scary, especially when you’re a beginner. It’s also often seen as risky. You’ve probably heard of people who’ve lost money over “timing the market” or making wrong financial decisions. 

But here’s the thing, investing isn’t as scary as people make it out to be, and unfortunately, without investing your money, it’s difficult for you to build long-term wealth and save up for financial goals like retirement. 

So, what’s one way you can earn some cash with investing, without losing sleep at night? One way you can invest without the stress is by using a strategy called Dollar-Cost Averaging. But what exactly is Dollar-Cost Averaging, and how does it work? 

You can think of Dollar-Cost Averaging as a simple and easy way to invest, because it adds a bit of structure to your investments, rather than having to guess. The benefit is that it may help you own more shares of a company over time for the same amount of money than if you had invested all of your money at one time. And if you’re anything like me and don’t have a lump sum to invest at once, it’s a manageable strategy that divides your money into smaller investments that you make over a longer period of time.

Here’s how Dollar-Cost Averaging works

With Dollar-Cost Averaging, you essentially invest the same amount of money into the same stocks or mutual funds at a regular interval. This is generally how 401k accounts work, too. You regularly contribute a certain amount to your plan and investment choices. In general, Dollar-Cost Averaging aims to limit the overall impact of volatility.

For example:

Let’s say you have $4,000 to invest in Schwab Core Equity Fund 

Instead of investing all of the $4,000 right away as a lump sum, you decide to use Dollar-Cost Averaging. You choose to invest $1,000 a month for 4 months. 

Based on historical data from Yahoo Finance, let’s look at a hypothetical example:

January: SWANX price is at $22.48 – You get 44.48 shares for $1000

February: SWANX price is at $20.43 – You get 48.95 shares for $1000

March: SWANX  price is at $17.77 – You get 56.27 shares for $1000

April: SWANX price is at $20.16 – You get 49.60 shares for $1000

In total, you invested $4,000 and got 199.3 shares. The average price now is $4,000/199.3 or $20.70 per share.

If you just invested a lump sum of $4,000 in the beginning at $22.48, you would’ve only bought 177.94 shares. 

Now that you have a general understanding of how Dollar-Cost Averaging works, Here’s how you can decide if it’s the right move for you and your money.

The Pros and Cons of Dollar-Cost Averaging

Pros:

  • It’s manageable – If you don’t have a large sum of money, Dollar-Cost Averaging allows you to break up the contributions into smaller investments.
  • It’s less stressful – Dollar-Cost Averaging can reduce emotional stress by eliminating market “timing,” and creates a regular system for our investments.
  • It’s low risk – Dollar-Cost Averaging reduces risky timing when you try to invest all at once.
  • It’s convenient  – Dollar-Cost Averaging essentially allows you to set up an automatic process that saves you time and energy. 

Cons:

  • No guarantee – As with any investment, there is no “guarantee”. Do your research and take the time to identify what works best for your situation. 
  • Lost potential – Stocks tend to have a more “upward bias,” so over a long period of time, there is the potential to not do as well than if you invested a lump sum. 

Key Takeaways: 

Dollar-Cost Averaging is an important concept to know when you’re just getting started with investing and can provide benefits for some investors. It generally makes more sense over a long period of time, and is better suited for those with a lower risk tolerance, and can erase some of the headaches that come with traditional investing With dollar-cost averaging, you have the convenience of setting up an automatic plan and you may also limit the risk of putting in a lump-sum of money all at once. 

However, as with any investments, Dollar-Cost Averaging involves risks so it’s important to do your research and understand what kind of investments you’re making and evaluate the pros and cons of each strategy that works best for you before investing.

Contributor’s opinions are their own. Always do your own due diligence before investing.

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