finance

Dollar Cost Averaging: Reducing Emotional Impulse

Dollar Cost Averaging: Systemic investment, typically monthly or quarterly, of the same dollar amount regardless of market performance.

 

Effects on your investment portfolio:

When the market is up– your dollars are able to purchase less shares because they will be more expensive.

Example: Say you allocate $100 each month to put in Mutual Fund A
JANUARY: Price is $200. You can buy half a share

FEBRUARY: Price is $100 . You can buy 1 share

When the market is down– your dollars are able to purchase more shares because they will be cheaper. Either way, you still invest the same dollar amount!

MARCH: Price is $50. You can now buy 2 shares
APRIL: Price is $25. You can now buy 4 shares


What the experts say:

Although I personally have found that the experts that I respect most favor this approach, there are pundits who argue on either side of Dollar Cost Averaging (DCA).

Those in favor argue that taking this approach will average out to getting you more bang for your buck, meaning you’ll spend less and get more in the long run. They also suggest that it’s safer to ease into the market slowly rather than throw everything in at once.

The alternative argument is the exact opposite- those against DCA say that your gains will be higher if you go all at once.

Penny Anthem’s Position:

Regardless if throwing your money in the market all at once or slowly investing will give higher returns, the returns are not what I value about this method.

There are two other very realistic and important aspects of taking this approach

1. It makes investing easier to manage for the small investor.
Not everyone has a huge sum of money that they can pour into the market at once. Most of us can only afford to invest X amount monthly.

Using DCA allows one to work their investing into their budget. This instills really awesome budging habits while slowly getting into the market!

2.  It reduces the emotional impulses we have when the market fluctuates.
We all know the old adage. Buy Low Sell high. But when the market starts moving in either direction, it seems to be human response to respond drastically, and in the opposite of what we know logic says!

Emotional-Cycle-of-Investing-2
Photo Credit: TCI Foundation
When the market is at it’s peak, and we have the most to lose- we are the most excited and confident. Similarly, when the market is dropping, and we have the opportunity to buy securities on clearance, we become depressed, scared, and panicked.

Dollar cost averaging allows one to reduce their emotional impulse. If you have a sound portfolio, and continue to invest systematically- you’ll be less likely to freak out.


Disclaimer

 

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