When I started learning how to take control of my financial situation and the bad choices that I had made along the way (sticking my head in the sand being one of the choices), I found out about a few magical things that occur when you’re saving and investing. Dollar cost averaging (DCA) is one of those things that just blew my mind. It is a simple yet powerful investment technique that involves investing a fixed amount of money at regular intervals, regardless of market conditions.
This approach offers several benefits including reducing timing risk. By investing consistently, you avoid the pitfalls of trying to time the market, I mean, not even the money managers seem to be able to do that, so it’s rather unlikely that you and I can pull it off, at least not consistently.
Dollar cost averaging smooths out market volatility by helping to mitigate the impact of short-term market fluctuations on your overall investment. You’re essentially spreading your investments over time which helps to average out the purchase price of your assets. If you invest a fixed amount of money, say, monthly, regardless of market conditions, the share prices will vary when the market fluctuates up and down. When prices are high, your fixed investment amount buys fewer shares so you’re buying fewer shares at a higher price. When market prices are low, the same amount buys more shares but at a lower cost. The averaging effect over time often results in an average share price in between the highest and lowest prices during your investment period.
I take back what I said earlier, we CAN time the market, by not ‘timing’ it. Just average it out.
Another benefit of dollar cost averaging is that it promotes disciplined investing, and our regular contributions become a habit, helping us stay committed to our long-term financial goals…you do HAVE financial goals, don’t you????
Let’s break down the mechanics of DCA and how you can take advantage of this phenomena today.
First, choose an investment. Let’s say you select a diversified index fund or ETF that tracks a broad market index. Since the S&P 500 is at a record high as I write this, you could look at Vanguard’s S&P 500 Index ETF (VFV) if you’re in Canada or Vanguard’s S&P 500 ETF (VOO) if you’re in the US. These both give you a diversified portfolio of companies in the S&P 500 index. But don’t just take my word for it, do your homework.
Next you want to determine your investment amount. Decide how much you can comfortably invest each month and set up automatic contributions for every time you get paid. Arrange for automatic transfers from your bank account to your investment account on a specific date each month. If you haven’t got an investment account yet, then you have more homework to do, I feel another blog post coming on! In the US look at organizations such as Vanguard Personal Investor – the platform allows for automatic investments and is known for its low-cost options, particularly Vanguard products. It’s described as ‘a bit clunky but works.’ In Canada consider brokerages such as Questrade or WealthSimple.
Setting up the accounts and the automatic savings from your bank can often be a bit of a pain in the a$%, but once you’ve got the adulting out the way ensure you either set up the automatic investing, or put a reminder in your calendar so you can do this yourself on a monthly basis. I do it myself as I love it, but I’m a bit of a finance nerd like that and I love to be in total control of every penny I make and spend. Once you’re investing you can continue learning, reading and researching. You might start looking to purchase a few different types of ETFs or assets, but first things first.
The key to benefiting from dollar cost averaging (and indeed building wealth) is to stay consistent. Continue investing the same amount regardless of market conditions. Investing regularly, such as monthly as I’ve mentioned, offers several advantages, including capitalizing on compound growth. The earlier and more consistently you invest, the more time your money has to grow through compounding.
You’ll also reduce the emotional decision-making, we have to take emotions out of investing and regular investing helps remove emotions from the equation, preventing panic selling during market downturns or FOMO buying during bull runs.
So, instead of saving up in your bank savings account and only earning a measly 1% interest, it’s time to take the plunge and start building some wealth already. And don’t wait until you have ‘a significant amount’ to invest, just start now.
Regularly investing through dollar cost averaging is a proven strategy for building long-term wealth, even during bull markets (when the market is navigating upwards). By removing emotion from the equation and capitalizing on the power of consistency, you can potentially achieve better results while reducing stress and anxiety. Remember, the key to successful investing is not timing the market, but time IN the market.
What are you waiting for? Get gone and do some research. Here are a few links to get you started.
https://www.td.com/ca/en/investing/direct-investing/articles/dollar-cost-averaging
https://www.investopedia.com/terms/d/dollarcostaveraging.asp
https://www.investopedia.com/articles/forex/052815/pros-cons-dollar-cost-averaging.asp
https://www.investopedia.com/terms/b/bullmarket.asp
https://www.td.com/ca/en/investing/direct-investing/articles/bull-market
https://www.investopedia.com/insights/digging-deeper-bull-and-bear-markets