Plain English Investing in Bite Size Pieces: What is Dollar Cost Averaging?

Investing /
Favorite Posts

 

When is the best time to invest in the stock market?  It’s an age-old question without a good answer.  My smarty-pants answer would be, “When you have the money to invest.”  But when people ask the question, what they are REALLY asking is, “Is now a good time to invest in the market?”  They want to know about the timing of investing.  The trouble is, there is no good way to time the market.

If you look at market history going all the way back to the beginning, and if you plan to be invested for a long time (i.e. ten or more years), then it would be logical to advise you to invest now.  Statistically, the stock market grows over longer periods of time.  Thus, if you invest today, you should have a high level of confidence that in ten or more years, you’ll have more money than when you first invested it.

Invariably, though, someone follows that logic, invests his hard-earned money one day and then the next day, the market loses its collective mind and plummets.  New investors will often get spooked by such an outcome and pull their money back out of the market.  Doing so locks the losses that were just on paper into real losses of some of your principal.  The likelihood of this person investing again soon is not very high.

Trying to time the market is a fool’s errand.  There is a better way: dollar-cost averaging.

What is dollar-cost averaging?

Dollar-cost averaging (DCA) is a method of investing over time that takes all the stress out of deciding when to pull the trigger on getting your hard-earned money into the market.  All you do is decide how much to invest each month (or whatever interval of time you choose), decide the timing for investing it, and then do it, without fail.  No stalling due to a market downturn, and no rushing the investment due to a market upturn.

The best way to accomplish dollar-cost averaging is to automate it.  If you participate in your employer’s retirement plan (such as a 401(k) plan), you are already doing DCA.  Your monthly amount to invest was predetermined by you and is invested at a regular interval by your plan provider.

Why does dollar-cost averaging work?

Throughout the course of a year, the stock market goes up and down repeatedly.  Unfortunately, this movement happens with no discernable pattern.  This is why trying to time your investment into the market is a losing proposition.  The odds are just not in your favor that you will get it right.

By using DCA as your method, you are removing the emotion involved in deciding the best time.  Some months your investment will go in when the market is temporarily down, and some months your investment will go in when the market is temporarily up.

The concept behind dollar-cost averaging is that over time, you are averaging the cost at which you are buying into the market.  Because this happens over a long period of time, you end up buying more shares at lower prices than you do at higher prices.

Is dollar-cost averaging always the best way to invest?

Whether or not dollar-cost averaging always wins the day is a loaded question.  I began with the assertion that if you plan to invest for the long haul, investing all you have to invest right now will likely pan out to be the best approach.  The caveat is the bad-luck scenario that you invest immediately prior to a large market downturn.  Even then, one can argue that in ten, fifteen, twenty years, the market will be higher, so ultimately, you’ll come out ahead.

Regardless of how well you manage your emotions when it comes to investing, immediately losing 20 percent of your investment is pretty darn depressing.  Unless you are a cold-hearted ninja when it comes to riding the waves of the market, plan to dollar-cost average your way into your investments.

What questions do you have about investing or other financial topics?  Share them below!  Or if you want to start a discussion with some like-minded friends, join the free SimpleMoney Community on Facebook to share your ideas!  In fact, we have an accountability group in the community to help us achieve our 2019 financial goals.  DON’T MISS IT!!

You might also enjoy:

Plain English Investing in Bite-Size Pieces:  All About Mutual Funds

Plain English Investing in Bite-Size Pieces:  What the Heck are Stocks?

Plain English Investing in Bite-Size Pieces:  What the Heck are Bonds?

 

P.S.  If you like what you read, subscribe to our free weekly newsletter!  This will keep you up to date on the week’s blog posts and podcast episodes, but also includes content only available to subscribers!  

 

 

 

Leave a Reply

Your email address will not be published. Required fields are marked *