How Does Dollar-Cost Averaging works

The amount of financial terminology is enough to send anyone into a panic when you enter the world of investing. So today, we will cover Dollar-Cost Averaging.

Long-term investors often use the term, especially when the markets begin to pull back or fall entirely on its face.

Readers keep asking about it, and the question often goes something like this:

“Dear Joey,

I keep hearing about dollar-cost averaging on my investments, but I’m new to investing and don’t understand it. So how does it help me in the long run?”

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What Is Dollar-Cost Averaging?

Simply put, it means that you set an amount of your paycheck to invest itself automatically, or you can do it manually as well. In addition, the strategy takes advantage of the stock market fluctuations. Every time you buy shares, the overall cost will average out between all your shares while the price goes up and down.

Let’s analyze the picture below:

Table Summary of Dollar-Cost Averaging

This person set a monthly amount of $100 (Set amount column) to invest at the beginning of every month (Date column). The stock they invested in fluctuated between $20 and $25 during the year (Stock price column). And the last column shows how many shares this person was able to buy each month.

At the end of the year, the person bought a total of 54.41 shares (Total column) while investing $1,200. When you have the two numbers, you can divide the total amount ($1,200) by the total amount of shares (54.41), and you get the number $22.06.

That means that the average cost of all your shares is $22.06. So you effectively average up and down throughout the year to not buy at the top or the bottom.

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Advantages of Dollar-Cost Averaging

When you buy with a set amount throughout the year, you ensure to not overpay for your shares. The market mainly moves upward, but it also has down moves. Therefore, they provide excellent opportunities for you to buy more shares at lower prices. In contrast, you buy fewer shares when the prices are high.

Things to Consider

Dollar-Cost Averaging is an excellent strategy if you are a long-term investor. You are not trying to time the market. Instead, you want to have time in the market while accumulating shares and taking advantage of the famous “the average return over the last 100 years is 10%”.

That doesn’t mean that the market goes straight up each month to end at 10%. Instead, the market fluctuates up and down but, in the end, finishes on average with a 10% increase.

Overall, it is a powerful strategy when you don’t want your money to sit on a bank account with a bit of interest of less than 1%. Instead, you will grow your account and net worth slowly but surely. If you are new to investing or don’t have much time to analyze the markets, consider this a great strategy.

Now, begin your Road to Wealth!

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