What is dollar-cost averaging?

Investing can seem too complex or impossible for the average investor. People think it is too risky. They are afraid to make mistakes and lose money.

Well, I  can tell you that those beliefs are simply not true. If you have the willingness to learn and you put the efforts to do so and understand, those efforts will pay off. You’ve already taken a big step simply by being here and reading this.

I’ll share with you a simple tip that I’ve learned that can reduce the stress of making mistakes and help you grow your wealth securely in the world of investing.

In today’s digital world, we got used to getting what we want in a matter of minutes. You want to know the temperature outside? Just ask Google. You don’t know what a word means? Just ask Google. You want to get the directions to get somewhere? You know what to do.

We have been trained for many years to chase our goal through the fast lane. This habit can be very expensive when applied in the world of finance.

An example of error many people do is trying to time the market. This can result in a lot of pain and cost people to tumble back to the starting point.

 

With the stock market going up and down all the time, when we want to invest in it, our brain is wired to chase the best result possible. What would be the first idea we would think of? Most people would say, wait for the market to drop significantly and buy when it’s cheap. This seems logical, who wouldn’t want to buy low and sell high?

This technique has a name, it is called lump sum investing. Which consists of waiting for the right opportunity to put a lot of money at once. Looks like a good idea? If you are the luckiest person in the world, maybe, but I’ll save you some trouble and give you the answer: if you want to grow your money on the long-term, that is not the way you’ll want to do it.

What is the best technique for long-term investing?

You’ve probably guessed it by the title of this post. If you want to grow your wealth over time by reducing the risk of losing money in the market’s ups and downs, you should invest using a technique called dollar-cost averaging.

Instead of waiting for the right moment to put a big sum of money, you would invest the same amount of money at the same interval of time, every weeks or month by example. By doing this, you reduce the impact of the market’s volatility on your money. In simple words, sometimes at the time you buy an asset, the price will be high, sometimes it will be low. In doing so, you will benefit from the average of the highs and lows of the market. We can never predict when the market is at its lowest, so just keep it simple. Buy the same amount at the same interval, simply by being “in” the market and not waiting for a good deal, your money works hard to make you more money.

There is an important thing to keep in mind here. If you already have an amount that you are ready to invest, Vanguard made a study comparing the lump sum investing vs dollar-cost averaging available here:

https://personal.vanguard.com/pdf/s315.pdf

In that scenario, two times out of three, you will get better results by investing it in a one-shot deal over using dollar-cost averaging on the same period.

This is not the same as for long-term investing using dollar-cost averaging. The key difference between what I am talking about and the study made by Vanguard, is that you start out without money to invest. Over a longer period, if you want to invest $1,200 a year you will get better results by using dollar-cost averaging and investing $100 every month than waiting to have bigger chunks of money and trying to time the market for the lows.

I’ve been doing that personally and I got to say, it is pretty cool not having to stress before every investment I make. I know sometimes, the market will go up, sometimes it will go down. I am expecting that. I enjoy a lot more being able to have a good cup of wine without having to worry if I had a bad timing with my previous investing decision.

 

I hope you’ve learned something you can apply to your life and enjoy.