Friday, February 17, 2012, AM | 17 Comments
Dollar Cost Averaging (DCA) is the process of investing the same amount of money every month over an extended period of time, regardless of whether the market is up or down.
By doing so, more shares are purchased when prices get to be low and fewer shares are purchased when prices get to be high. This allows you to spread your purchases over time and lessens the risk of investing a large amount in a single investment at the wrong time.
Dollar Cost Averaging is time-proven investment technique and has generally two-fold characteristics:
- You should increase the amount of money you invest as your income increases.
- You should not make changes because of what the market is doing or what you think it might do.
Furthermore, Dollar Cost Averaging is:
Even modest monthly investments can grow to substantial amounts due to the power of compounded interest
It takes the emotion out of investing
It avoids the pitfalls of market timing
You can invest small amounts
By investing the same amount each month, you automatically purchase more shares when prices are down and fewer shares when prices are up. In a volatile period, the result of this can be a lower average cost. Hence the term, Dollar Cost Averaging.
When you get your tax refund this year, you have a choice of investing the amount one of two ways:
Investing a Lump Sum
Instead of dollar cost averaging, what if you invested a lump sum amount. If you invest it all at once, the market could go down and the value of your investment would drop sharply. This might be more risk than you are comfortable taking.
A good alternative
A good alternative is to divide your lump sum into equal amounts and invest them over a number of months (6 to 12). This way, if the market drops right away, you have suffered a smaller loss and can buy more shares each month at the lower price.
However, Dollar Cost Averaging is not without its own risks.
If the market goes up, and stays there, you may regret not investing all at once since you will be buying future shares at a higher price.
Systematic investing does not assure a profit and does not protect against loss in declining markets.
Systematic investing involves continuous investment in securities regardless of fluctuating prices. You should consider your financial ability to continue purchases through periods of low price levels.
DCA risks are low compared to investing lump sum
It turns out that you very seldom lose with dollar cost averaging strategy of investing. Invest the average tax refund whatever you receive rather than spending it recklessly. Divide the amount into 6 or perhaps 12 equal installments and invest the amount at regular intervals.
While there is no guarantee that you will have a gain when you sell, dollar cost averaging may help reduce investment risk. It can help build investing discipline.
And remember, the best way to lose your money is by trying to make money too fast! The best financial strategies in the world go the drain everyday. Very few take advantage and needless to say the ones who do are millionaires and probably billionaires.
In a Nutshell
It’s always easier said than done to invest. We just make excuses not to invest.
You could start investing 20 bucks a month and over the years you would see the rewards.
Find the best dividends at Dividend Stocks Online.
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