Dollar-Cost Averaging is the investing strategy in which the investors invest a fixed amount over time to acquire a target asset such as a stock, bond, or other investment projects. It will allow investors to reduce the impact of volatility on total purchase at the beginning of the period. Investors will purchase the target asset by spending a fixed amount of money over a specific period without considering the asset’s market value.
By using a dollar-cost average, investors will be able to purchase the asset at the average price over a specific period. Investors will not face the risk of purchasing during the bear market.
Dollar-Cost Average Example
Mr. A decides to invest 15,000 into company A share. Instead of purchase share at once, he uses the dollar cost average method. He will invest 5,000 per month over a period of 3 months.
In the first month, the share price is 100 per share and he purchases 50 shares
In the second month, the share price increase to 102 per share and he purchase 49 shares
In the third month, the share price decrease to 90 per share, he purchases 55 shares
So in total, he spends 15,000 to acquire 154 shares. He spends on average of $ 97.4 per share ($ 15,000/154 share). Rather than spend all money and get only 150 shares in the first month.
Advantages of Dollar-Cost Average
Reduce Risk of price fluctuation
This method will help investors to purchase the share at an average price which balances between risk and return.
No need to time the market
Timing market is almost impossible, we will end up purchasing at a higher price if compare to the dollar cost average.
Spend time on operation rather than predicting the market
Management should spend time on business operations rather than observing the market to predict the price.
Work for long term investment
This strategy works very well for investors who look for long-term investment. They will not look to sell the investment in a short time. Base on the research, the stock market tends to increase in the long term even there is a downturn during in some short time. These investors will not care about the price fluctuate which happens every day or month.
To Show the commitment
By using this strategy, the investor needs to put pressure to invest rather than waiting for the right time which will never exist. They have to commit to the plan and make investment possible. The earlier they decide to make the plan, the better it will be.
Reduce Fear and Uncertainty
We need to look at the company’s long-term strategy so it is found to face some change in price in the short term. Our objective is to invest in company that we believe at a certain time without timing the market.