Investing can seem intimidating and complex, especially if you’re new to the world of finance. There are so many different investments and you might not know how to create an investment strategy.
If that sounds like you, you’re in the right place!
One approach that has gained popularity because it’s simple and highly effective in the long term is called dollar cost averaging.
Today, I’m going to dive into dollar cost averaging – what is dollar cost averaging, how it works, its advantages, and I'll give you a step by step guide so you can start dollar cost averaging with confidence.
What is Dollar Cost Averaging?
Dollar cost averaging is an investment strategy that involves consistently investing a fixed amount of money at regular intervals, typically monthly or quarterly, regardless of the current market price.
Basically, you decide on a fixed amount of money that you’re going to invest at a pre-established regular interval. For example, maybe you decide you’re going to invest $500 every month.
This is a great long-term investment strategy.
I’ll explain exactly how to do dollar cost averaging step-by-step in a minute, but first, let me explain the advantages…
Advantages of Dollar Cost Averaging
1. Mitigates Market Timing Risk
Trying to time the market is a major investing mistake. Very very few people are able to time the market well enough to gain any advantage – most people lose money trying to time the market. Dollar cost averaging removes the need to predict the "right time" to enter the market. Whether the market is high or low, you continue to invest, avoiding the emotional rollercoaster of trying to time the market.
2. Creates Discipline and Consistency
Dollar cost averaging instills discipline in your investment approach. By committing to regular investments, you develop a steady, long-term mindset that can lead to more significant wealth accumulation over time.
3. Reduces Volatility Impact
Since you buy more shares when prices are low and fewer when prices are high, dollar cost averaging reduces the impact of market volatility on your overall investment. This can help manage risk.
4. Lowers Stress
Dollar cost averaging can lead to lower stress levels. Instead of worrying about daily market movements, you simply stick to your predetermined investment schedule.
5. Demolishes Analysis Paralysis
Many potential investors suffer from analysis paralysis, never starting because they are unsure of when to jump in. Dollar cost averaging overcomes this by making the start as simple as choosing an amount to invest and a schedule to stick to.
How to Start Dollar Cost Averaging
1. Choose Your Investment
Start by selecting the asset or portfolio you wish to invest in. It could be a stock, an exchange-traded fund (ETF), or a mutual fund. Personally, especially if you’re new to investing, I would go with ETFs. If you want to learn more about what ETFs are, how they work, and why they make a great investment, we have a full video on that, which I’ll link in the description.
2. Decide How Often You'll Invest
A lot of people who use dollar cost averaging invest once a month or once a quarter. Personally, I think once a month is a good cadence.
3. Set the Investment Amount
Determine how much money you can comfortably invest at each interval. This should be an amount that won't strain your finances. So, for example, say you make $6,000 a month. Let’s say half – $3,000 – goes to necessary expenses, like groceries, utilities, and your rent or mortgage. Of the remaining $3,000, you use $1,000 for fun things, like enjoying a nice dinner or visiting a museum. That means you have $2,000 left over.
Assuming you’re already in a good place financially (meaning you don’t have any high interest rate debt and have a robust emergency fund stashed away), then you could plan to invest $1,000 every month and put the other $1,000 into a high yield savings account, where it’ll be growing and still accessible.
Of course, this is just an example. Be sure to look at where you are financially and decide the best amount for you.
4. Open an Account
If you don't already have one, open an investment account with a brokerage or financial institution.
If you need help picking a brokerage, we have a full video analyzing some of the most popular brokerages, which I’ll link in the description.
5. Automate Your Investments
Many brokerage platforms offer automatic investment plans that allow you to set up recurring transactions, so if you want to invest $1,000 every month, you can set it and forget it. This makes the process more convenient and reduces the risk that you’ll forget.
6. Monitor and Adjust
While the essence of dollar cost averaging is consistency, you should occasionally review your investments and make adjustments as needed to ensure they align with your financial goals.
For example, if you want to buy a house, you may want to pull back on investing and put more money into a high yield savings account, where it’ll be more easily accessible when you make your purchase. On the other hand, if you get a raise, you may want to increase the amount you’re investing.
Ready to Invest?
To sum it up, dollar cost averaging is a simple but powerful investment strategy that allows you to build wealth steadily and manage market volatility effectively. By committing to regular investments, regardless of market conditions, you can reduce risk, increase discipline, and minimize the emotional stress associated with market fluctuations.
Whether you're saving for retirement or building a nest egg, dollar cost averaging can be a reliable tool in your investment toolkit, helping you achieve your financial goals over the long term.
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