There are quite a few tactics and strategies in the stock market that help reduce investment costs for traders. One of these is the dollar cost averaging tactic. As a bonus, the tactic also helps reduce risks associated with an investment, long-term, at the same time.
Under such a tactic, investors and traders invest the same amount of money at regular intervals in a particular security. However, dollar cost averaging might not be the best tactic for everyone, but if and when done right, it can end up working out better than other investment techniques.
To help you understand the question of “what is dollar cost averaging?”, here is everything there is to know about it in this blog.
What Exactly is Dollar Cost Averaging?
Controlling the price risk associated with various stock and mutual fund investments is extremely important to lessen the chances of losing any money. With the help of dollar-cost averaging, traders can diversify their portfolios better as they will be purchasing a lesser number of assets regularly instead of investing in one particular asset at a fixed price.
With this strategy in mind, traders end up minimizing the danger that comes with overtly investing in an asset before the market decides to decline. Spreading your purchases out over an extended period is a better option for investors as it will help you accumulate wealth better with the help of dollar cost averaging.
Market Timing vs. Dollar Cost Averaging
Who Can Benefit from Dollar-Cost Averaging?
The best part about dollar cost averaging is that it helps investors start their investment journey by investing tiny amounts, instead of doing more, in one go. This works best for investors or traders who do not have a lot of money to invest, in the first place. Now, thanks to dollar cost averaging, one does not have to wait to accumulate money before they begin their investment journey.
Even when the market is on a decline, with the help of the dollar cost averaging strategy, you can continue investing monthly. If one does not continue to invest in their assets during market downturns, the chances of them losing out on future opportunities for growth are high. It is a fact that investors and traders who choose to let their money stay in the market during bearish markets gain higher returns in the long run than traders who withdraw their money and then try to invest when the market is recovering.
The Downsides of Dollar-Cost Averaging
Like any other investment strategy, where there are advantages, there will always be a couple of disadvantages or drawbacks too.
It is a fact that markets grow over time, and that is precisely why it is difficult to predict the value of stocks on any given day, week or even year. This is why, when, as a part of the dollar cost average strategy, you add assets into the market slowly and gradually, you end up preventing any potential short-term market volatility. However, this method is also accompanied by the fact that some of your funds are just lying on the side without contributing to your financial health.
When investors decide to use dollar cost averaging to invest in a dividend company, getting dividends on the money that you have not invested yet is impossible. This is why looking at dividend-paying stocks or other income-producing assets is not a great idea when using dollar cost averaging.
You also cannot use dollar cost averaging to make up for poorly picked stocks. There is no doubt that dollar cost averaging can definitely calm the nerves of an investor, but you need to choose the right stocks to see good returns on your investments either way.
Final Thoughts
Dollar cost averaging can be a great investment strategy to use when investors are low on funds but still want to be a part of the stock market and invest to earn returns in the long run. There are several benefits to the strategy as well as a couple of drawbacks that are not necessarily a gamechanger. This is why the importance of the stocks you choose to invest in through the method, to ensure good returns in future.
Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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