Dollar cost averaging in investing
Dollar cost averaging, or DCA.
Why do you need it?
What is dollar cost averaging, and
How to use dollar cost averaging in investing.
Investing in the stock market comes with very strong emotions for a lot of people.
If you suffer from FOJI, the Fear Of Joining In, your main concern is that if you buy stocks and they go down in value, you’ll be unhappy you bought them. This might lead you to postpone the transaction, or not invest ever.
If you suffer from FOMO, the Fear Of Missing Out, your main concern is that if you don’t buy a stock and it goes up, you regret not buying them. This might create too much urgency to buy right now, jumping in recklessly and taking the risk of “blowing up”.
In both cases, dollar cost averaging might be a way to deal with your emotions.
You don’t HAVE to buy 100 shares in one go, you don’t HAVE to spend the $10,000 in just one lump sum transaction.
⏱️TIMESTAMPS⏱️
00:00 The emotions of investing
01:02 Dollar cost averaging definition
01:27 Dollar cost averaging example
03:15 Benefits and risks of dollar cost averaging
03:58 DCA based on number of shares
05:22 How NOT to use dollar cost averaging
06:46 Reverse dollar cost averaging
Dollar cost averaging is buying into a position in multiple steps in a disciplined way, avoiding the temptation to “time” the market. Dollar cost averaging can take away some of the emotions of #investing in the stock market. You can apply #dollarcostaveraging to shares, index funds, mutual funds, currencies, and a broad range of other securities.
Here’s an example of how to use dollar cost averaging in two steps in buying shares. How about we buy just 50 shares, rather than 100, at $100 per share, for a total transaction amount of $5,000. Then somewhere in the future, we spend another $5,000 for the second step of the transaction. What we don’t know right now, is how many shares that $5,000 is going to get us at that future date. But we do commit to buying additional shares at a pre-set date, for example one month from now, or one year from now. And if you feel more comfortable splitting the buy into 5, 10, 12 or 20 steps, rather than just two, be my guest!
Here are two of the many possible scenarios of how dollar cost averaging could work out in this case. Remember that nobody knows for sure what the share price will be in the future. Buy 50 shares at $100 per share today, for a total of $5,000. Then in the second purchase, when it turns out the share price has increased to $125 per share, buy 40 shares, for a total of $5,000. You now hold 90 shares which you bought at a dollar cost average of $111 per share, for a total of $10,000.
Second scenario. Buy 50 shares at $100 per share today, for a total of $5,000. Then in the second purchase, when it turns out the share price has decreased to $50 per share, buy 100 shares, for a total of $5,000. You now hold 150 shares at a dollar cost average of $67 per share, for a total of $10,000.
One of the benefits of this version of DCA is that it causes the investor to buy more shares when prices are low and fewer when they are high.
Where’s the catch in DCA? Are there any downsides to dollar cost averaging? There could be! Beware of transaction costs, these could be higher if you split your purchase over multiple buys rather than invest one lump sum. Don’t let the transaction cost monster eat up your investment returns! What you need to add to your to do list is to check the transaction fees with your broker, these might include a fixed component per transaction as well as a variable component related to the size of the order.
What is reverse dollar cost averaging? The opposite of regular dollar cost averaging! In reverse dollar cost averaging, you are selling out of a position in multiple steps in a disciplined way, avoiding the temptation to “time” the market when exiting a position.
Philip de Vroe (The Finance Storyteller) aims to make accounting, finance and investing enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better investing decisions. Philip delivers #financetraining in various formats: YouTube videos, livestreams, classroom sessions, and webinars. Connect with me through Linked In!
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