While high volatility can send many investors into a panic, would you be surprised to learn some investors welcome a volatile market? The swings of a volatile market can be harnessed into something great. How? By using the long term investment strategy of dollar-cost averaging.
If dollar-cost averaging sounds like an old concept to you, it’s time to look at it with fresh eyes. This is a 101 investment strategy for anyone who has taken a basic finance course. You may have seen this years ago in a lecture hall at a time in your life when you weren’t so interested. There’s nothing fancy here, it’s mathematical, and the time may be right to revisit it.
This strategy works as well for experienced investors as it does for beginners. Dollar cost averaging loves a volatile market.
Am I a believer in dollar cost averaging? You bet. It's a winner in my books.
How does dollar-cost averaging work?
Dollar cost averaging is a disciplined approach where you invest a set amount of money at regular intervals. For example, you could invest $100 once a month, once a week or biweekly depending on your budget and what suits you. You can use any combination of regular investment amounts and intervals.
The market moves up and down on a daily basis. When you invest smaller amounts at regular intervals, each time you make an investment you are purchasing at a different unit price, and a different number of units of an investment.
Dollar cost averaging investors often welcome market dips because they know they are purchasing more units with their money at lower prices and will benefit as the markets rise again. This process takes advantage of the fluctuating prices
For simplicity, let’s look at an example of an investor making regular investments into a mutual fund.*
Average of share prices: $8.67 (10+6+8+11+7+10=52, divided by 6)
Your average cost per share: $8.26 ($600/72.6)
*This is a hypothetical example courtesy of CI investments to illustrate dollar cost averaging and not intended to resemble any particular investment fund.
By investing a fixed amount you buy more units if the price is lower and fewer units if the price is higher. You can see in this example, while the average of your share price would be $8.26, your average cost was only $8.26. It lowers the average cost per unit of your investments, and provides potential for higher capital appreciation, assuming the market is moving in both directions.
Set it up and let it do the work
Let’s be clear – it is never a good idea to completely ignore your investments, but sometimes going on autopilot isn't a bad idea, especially when the alternative is not getting started at all. Let dollar cost averaging do the work. This disciplined approach makes it easy to stick to small amounts which will add up to something big in time.
It keeps you investing no matter what is going on in the market and removes temptation to bail during volatile times. There is also a reason to be satisfied knowing you are automatically purchasing units in a down market at a discounted price.
Am I a believer in dollar cost averaging? You bet. Personally, I invest weekly and have done so for years. Dollar cost averaging is a winner in my books.