What Is Dollar Cost Averaging And Why Should You Care?
Nowadays there is a growing number of people that use DCA (dollar cost averaging). It is also known as pound-cost averaging in UK, unit cost averaging or constant dollar plan in the USA.
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We are talking about an investment strategy that is used in order to reduce volatility impact when purchasing large financial assets like equities. The investor will divide the money that is to be invested into various equal amounts, set up through intervals. For instance, when you have $100,000, you would invest $1000 per week for a period of 100 weeks.
When you use dollar cost averaging, you drastically reduce the possibility of ending up with a substantial loss that appears when you invest the entire sum. Market falls do happen and DCA is one of the methods used by investors to minimize risks while also increasing the possibility of making more money on the long run.
When Should The Strategy Be Used?
DCA is best employed when faced with investments made in markets where temporary declines can happen. That is due to the fact that only a portion of the lump sum ends up declining. The name of the strategy is used because of reducing average share costs when making purchases. The amount of shares you would be able to buy for one amount will inversely vary when comparing with price. Dollar cost averaging will make you buy more shares when prices are lower and fewer shares when costs are higher. The entire cost per share is thus reduced.
Investors will need to decide on 2 parameters: the overall time horizon when investments are made and how much money will be used on one investment. When the investor focuses on shorter time horizons, DCA will behave a lot more like investing a lump sum. In most situations, when using the stock market, businessmen tend to balance risk and return through investments of 6 months to 1 year.
Just as with any investment strategy, DCA was praised by some and criticized by others. There are different financial advisors that will tell you to use DCA because it can reduce financial risks linked with a single purchase. Others will tell you that this method is not a good investment strategy. While many market studies were done in the past, nobody can actually tell you if this is the type of investment that you should make or not.
Should You Use Dollar Cost Averaging?
The life of an investor is undoubtedly linked to the risks that he wants to take. Some people will love this method because of the lower risks but others will believe that it is not at all great since more money can be done in a shorter period of time when finding good investment opportunities for the entire lump sum. At the end of the day, you are the one that has to choose but it is always a good idea to at least consider DCA in the event that you are just starting out investing.