Is Dollar Cost Averaging A Smart Strategy?
*Disclaimer: Ethos' content is intended to provide general education about dollar cost averaging. You should consult a financial planning professional before making investment decisions.
What is dollar cost averaging?
Dollar cost averaging involves making small contributions to a fund or individual stock over a long period of time, rather than investing a large chunk of money at once. It's a strategy that's often favored among more risk-averse investors. If you have a 401(k) through your job that makes contributions with each paycheck, the idea is similar.
One of the biggest appeals of dollar cost average investing is that it limits the volatility of your investment. When your contributions are spread out over a longer time period, there's less pressure to time the market, which can lead to emotional investing.
How does dollar cost averaging work?
The typical dollar cost averaging strategy is easy, even as an individual investor. To dollar cost average, you start by choosing an amount of money you want to invest and an asset to invest in. Then, you invest the money in equal increments over a fixed period of time. You continue to invest the money at your scheduled interval, no matter the asset's price.
Here's an example. Let's say you want to invest $10,000 in Tesla, but trend charts indicate that the stock is very volatile. Rather than investing $10,000 at once, you could dollar-cost average instead and invest $500 every week for 20 weeks, or $1,000 for 10 weeks.
There's no specific dollar cost averaging formula. It's up to you to decide how much money you want to invest in total, how often you wish to contribute, and how much you want to invest at each interval.
Differences between dollar cost averaging vs. lump sum investing
If you aren't dollar cost averaging, you may be investing in lump sums. Lump-sum investing is essentially the opposite of dollar cost averaging.
When you invest with a lump sum strategy, you contribute a large amount of money at once to an asset. You may decide to invest a lump sum when a particular asset is down, for example, or when an asset starts to gain value.
Lump sum investing typically relies on timing the market. You wait for an asset to trend in a certain direction (upward or downward) and put a large amount of money in with the hopes of maximizing the money's growth.
Using the Tesla example from above, a lump sum investor would have purchased $10,000 worth of shares at once, rather than breaking it up into smaller investments over a long period of time.
Is dollar cost averaging a good idea?
While dollar cost averaging is an excellent approach for some investors, it also has drawbacks. Overall, dollar cost averaging can be a good idea for investors who want to invest in volatile assets, as it can reduce the investment risk. In theory, when you invest consistently during the dips and peaks, the fluctuations even out.
Using dollar cost averaging as your investment strategy can also make the process of investing less stressful. There's no need to closely monitor an asset's performance, time the market, or contribute a considerable amount of money without knowing what will happen.
It's also a reasonably hands-off approach, which can be a good place for new investors to start.
However, like most investments, dollar cost average investing isn't guaranteed to make you money. It's possible you could make more money with a lump sum investing approach. Dollar-cost averaging can lower risk, but in turn, you could lose out on more significant gains.
Ultimately, investing is highly personal. The best investing strategy for you depends on your risk tolerance and goals. Dollar cost averaging may be an appropriate method for some people, whereas others are more comfortable with a lump sum approach.
There's no right or wrong way to invest. Putting money into volatile assets always carries a certain amount of risk, and it's impossible to time the market or predict market movement, no matter how experienced you are.
Adding life insurance to your investment strategy
If you're looking to double down on your financial planning strategy, consider adding life insurance to your long-term plan. You can even invest your tax return in a life insurance policy to limit out-of-pocket impact.
Having life insurance is incredibly beneficial, even if your investments alone could provide financial protection to your loved ones in the event of your death.
Through Ethos, you can choose from various policies with no medical exam required (simply answer a few health questions). Our policies are underwritten by some of the biggest names in life insurance. It's easy to get a free quote online. Your coverage starts as soon as you pay the first premium, and most applicants can get coverage on the same day they apply.
The information and content provided herein is for informational purposes only, and it is not to be considered legal, tax, investment, or financial advice, recommendation, or endorsement. You should consult with an attorney or other professional to determine what may be best for your individual needs.