When it comes to investing in stocks, there’s no shortage of personal finance advice and techniques to follow. However, there’s no one strategy that can guarantee massive financial wealth.
That being said, there are some time-tested investment strategies that can help put you in a position to grow your portfolio with minimal risk. One such strategy is dollar-cost averaging, which is an effective way to grow your financial investments while protecting against the risk of significant loss.
What is Dollar-Cost Averaging?
Dollar-cost averaging involves investing a sum of money (usually a relatively small amount) into one particular stock at regular intervals, regardless of the stock’s current price.
The entire premise of dollar-cost averaging is not to try and time the market. In a perfect world, you would always be able to purchase a stock at the absolute lowest price possible, but given market complexities, timing the market is virtually impossible over a long enough time frame.
Instead of trying to time the market, with dollar-cost averaging, you commit to adding to your stock holdings over time regardless of short-term price fluctuations. This strategy can help set you up for long-term investing success, and it is incredibly simple to follow.
How Does Dollar-Cost Averaging Work?
Let’s say you are interested in investing in a particular stock, such as Tesla (TSLA), and want to add some to your portfolio. Let’s also say, for this example, you have $1,000 to invest.
One strategy would be to make a single lump sum purchase of $1,000 in Tesla.
If Tesla goes up 50% that week, you will be quite the happy investor. You could sell a portion of Tesla and walk away with a reasonably sized profit.
Of course, instead of Tesla going up 50%, it could also swing the other way, leaving your initial investment barely a fraction of what it was. Depending on your investor tolerance for risk, you might be interested in the lump sum method.
Alternatively, you could use dollar-cost averaging. Instead of investing your entire $1,000 in a single transaction, you decide to invest $100 each week into Tesla over the course of 10 weeks. Each week, you would add a small amount of Tesla to your portfolio instead of buying as much Tesla right away with a lump sum transaction.
For this example, let’s say you started cost averaging on January 1st, 2022, and ended March 8th, 2002— ten total investments of $100.
Benefits of Dollar-Cost Averaging
- Stress-free investing: With dollar-cost averaging, you don’t need to be glued to your phone, stressing whether you’re getting the best share price. Dollar-cost averaging can help you take the emotion out of investing—you literally “set it” and forget it. The entire strategy is automated whether you’re investing in a mutual fund or individual stocks.
- Reduced risk: Dollar-cost averaging, in general, helps reduce your overall risk, given you’re buying over a prolonged period. Large swings in the market won’t affect you as much, particularly from a loss perspective. Essentially, you’re choosing less potential profits for more stability.
- Increased exposure: When you use dollar-cost averaging, you’re getting exposure to your desired stock, even if it’s in small dollar amounts, which again, helps you build your portfolio without worrying about the day-to-day price.
- Minimal capital requirement: Because you’re buying a stock at regular intervals regardless of the price, you don’t need a large amount of money to get started. Many investors just getting started may not have a large amount of money at their disposal. With DCA, instead, you could purchase fractional shares of a stock and work your way up to owning a full share over time.
Downsides of dollar-cost averaging in stocks:
- Lower potential for gains: By investing a fixed amount of money at regular intervals, you may miss out on the potential gains that come with investing a lump sum during a market upswing.
- Time commitment: Dollar-cost averaging requires a long-term commitment to regular investing, which may not be suitable for all investors.
Overall, dollar-cost averaging can be an effective investment strategy for those looking to investin stocks with minimal risk. While it may not offer the same potential for high returns as investing a lump sum, it can still potentially lead to gains over time as the market trends upward.
By investing a fixed amount of money at regular intervals, you can gradually build up your investment in a particular stock or fund, even if you don’t have a lot of money to invest initially.
For More Stock Trading and Educational Content, ClickHere.
