Whether you are trying to build wealth for retirement or you are looking to park your money somewhere and watch it grow, investing in the stock market is always a great solution.
Investing can seem like a daunting task especially with the ton of different strategies all with their own intricate complexities that exist. Dollar cost averaging offers a much simpler solution for your investing needs.
This strategy for entering the market recommended even by the legendary investor Warren Buffett [Link] has excellent returns.
In this article I will explain:
- What is the dollar cost averaging strategy
- Advantages of dollar cost averaging
- Which instruments to use it on
- How to take profits
Let’s jump in and get you started.
What is the dollar cost averaging strategy
Dollar-cost averaging is an investment strategy that involves consistently investing a fixed amount of money at regular intervals instead of trying to time the market with a single large lump sum investment. The idea is to commit a specific amount, monthly or biweekly, into a chosen investment vehicle which is typically an index fund or a group of stocks. Since the goal is stay in the market long-term, time will work with the investor to bring about returns.
Advantages of dollar cost averaging :
1. Efficient and Proven : This blueprint for long term trading has withstood the test of time. It has been back tested time and time again and always yields positive results. You can confidently follow this game plan since it has proven to work in the past.
2. Simplicity: In an unpredictable market, following a set plan can be difficult especially in times of turmoil. Having dollar cost averaging as a strategy gives you the confidence to invest regardless of what price has done, thus eliminating the need for any emotional or irrational decision making.
3. Automatic and low maintenance: This simple tactic is straightforward; some brokerages even allow auto deposits from your account into the stock market at regular intervals making it completely automated so you do not have to do anything at all after you set it up. If done actively, this strategy can be done while working full time needing no longer than 30 mins a month to execute.
4. Eliminates market timing risk from lump sum investing: Since this approach consists of always being in the market it eliminates the need to time market highs and lows. Buying the same dollar amount at regular intervals will ensure that a larger number of shares are bought at lower prices for positive returns.
Timeframe for dollar cost averaging.
Typically the longer time frame is better for dollar cost averaging. When doing United States index funds investing, staying in the market for over 5 years has a historically low chance of turning out negative with monthly installments (there are exceptions such as if you bought the NASDAQ index from 1997 to 2002 when it underwent the Dot Com bubble [link]). If you hold for 10 to 20 years, this has a great chance of a profit.
Which instruments to use it on
The longer time spent in the market the better the overall investment will turn out. A minimum of 10 years to have a great probability of a good return. However past performance is not indicative of future results and you should only invest what you are willing to lose.
A few instruments that have historically performed well :
- Stock market index funds: These are funds that contain many different stocks and in many cases have historically performed well. Since it is well diversified there is a lower overall risk and good potential upside. My favorite index funds to invest in can be found here.
- Exchange traded funds (ETFs): These can be a great alternative to index funds if you lack access. ETFs can mirror index funds and other instruments such as commodities, fixed income, currency and many more . There are always a lot of options to choose from for ETFs.
- Exchange-Traded Notes (ETNs): ETNs provide exposure to specific market sectors or commodities, allowing many different areas of interest.
- Other investments: Other investments that are riskier include individual stocks, bonds or other assets. The list goes on.
How to take profits
So we explained what dollar cost averaging is, its advantages and which instruments it can be done on. Since we know how to get in, how do we take profits? This depends on the goal of the investment.
If it is a retirement fund, it is best to wait until retirement. For a basic investing plan I would suggest waiting until the money is needed for something more important such as a home purchase. If ever you decide to start a business and are willing to risk the funds, this can be an adequate reason to take profits.
As long as the the money is going towards retirement or a better investment, it will be a great reason to take profits.
Happy Investing,
Andrew AKL
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