Dollar Cost Averaging (DCA) is a structured approach to buying investments. DCA is intended to temper the volatility of your investment portfolio by breaking large holding purchases into smaller buys done over time.
Instead of buying a large holding of a single investment vehicle all at once, the entire purchase is divided into smaller transactions and spread over a period of time. Let’s review what that entails.
What you need to know
Some investors are concerned that immediately after making a large investment, the price of that security or stock will fall, and they will incur a loss that must then be overcome.
Consequently, they fail to invest, keeping a portion of their holdings in cash or an underperforming investment that is not aligned with their investment strategy.
An example demonstrating how DCA works:
- An investor wants to make a $60,000 investment in a single stock
- The share price is hovering around $20, and will allow about 3,000 shares to be bought
- The rationale behind this purchase is a buy-and-hold strategy to collect dividends to reinvest, and produce a long-term capital gain
- Over the next 3 months, 3 equal purchases of the stock will be made
- On December 1st, 1,000 shares are purchased at $20/share = $20,000
- On January 1st, 1,110 shares were bought at $18 = $19,980
- On February 1st, 950 shares were bought at $21= $19,950
- A total of 3,060 shares bought for $59,930 at an average price of $19.58
Dollar Cost Averaging allows investors to mitigate some of the short-term risk associated with price drop immediately after purchasing. Without DCA, if an investor fully buys-in and the price immediately falls, they ‘should have’ waited.
With DCA, an immediate price drop as outlined in the example above allows more shares to be purchased for the same lump-sum amount. This can be especially helpful with a buy-and-hold strategy with a dividend bearing stock.
Another benefit of DCA is the structured discipline required to plan and execute the purchases. Investment decisions are typically made with a longer time horizon, and the adherence to the plan is higher, allowing the original purchase rationale to survive market volatility. DCA may be right for you – let’s talk about why or why not.
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