What is Dollar Cost Averaging? How can it help me?
One of the best ways to make money, aside from working, is to let our savings work for us. This is what is commonly known as “investing”. If you’ve ever looked into investing your money, however, you’ll know that it can quickly become complicated. Or just downright confusing.
There are so many options out there! You might have considered putting your money into a savings account earning 0.7% interest (if that) like 99% of Canadians. Maybe you thought of putting money into stocks and mutual funds. You might have even considered investing into your friend’s essential oils business which is really going to “quadruple your money in a month!”. Don’t actually do that last one.
Regardless of what investment you’re choosing, there are two different methods you might consider using: lump-sum or dollar cost averaging. Lump sum, as the name-implies, means putting in all the money at once. Dollar Cost Averaging, or DCA for short, means that you put a set amount of money in at set intervals, be it weekly, bi-weekly, or monthly.
As an example, let’s say you receive a windfall of $5,000. You might decide to put in all $5,000 right away as a lump-sum, or you could invest $500 every month via dollar cost averaging. Meaning by the 10th month you would have invested all of the $5,000. So exactly what are the benefits of dollar cost averaging? We will talk about 2 major benefits today: lowering the potential volatility and training yourself to be more comfortable with investments.
Lowering the potential volatility
The market is always fluctuating up and down. The truth is, no one really knows whether it goes up or down in the short term, not even financial experts. Using dollar cost averaging you’ll be able to lower your volatility. Let’s look at an example of how it works:
As you can see above, using the dollar cost averaging method, the person was able to purchase a total of 157.5 shares for $2000. Which means the average share price is equivalent to $12.70 per share. To a lot of people, this sounds less risky than potentially buying in at $25 or $20.
Training yourself psychologically
The much bigger benefit of dollar cost averaging however, is the fact that it actually encourages someone to invest! And we like to call that the “Secret benefit”. The truth is, as long as you’re investing your money for the long term, your chances of making money on the investment get better and better with a longer time horizon. For a lot of people, putting in a big chunk of cash in one go isn’t easy. However, it’s a lot easier for them to put in a little bit every week or every month.
Like everything else, investing comes with practice. Understandably, jumping into something right away can be a challenge. If you find yourself hemming and hawing over taking your money out of your savings account in order to start making it grow, dollar cost averaging may just be the strategy for you!