Active trading can be stressful, time-consuming, and still yield poor results. However, there are other options out there. Like many investors, you might be looking for an investment strategy that is less demanding and time-consuming.
But what if you want to invest in the markets but don’t really know how to start? More specifically, what would be the optimal way to build a longer-term position?
Dollar-cost averaging (DCA) is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase. The purchases occur regardless of the asset's price and at regular intervals.
In effect, this strategy removes much of the detailed work of attempting to time the market in order to make purchases of equities at the best prices. Dollar-cost averaging is also known as the constant dollar plan.
The main benefit of dollar-cost averaging is that it reduces the risk of making a bet at the wrong time. Market timing is among the hardest things to do when it comes to trading or investing. Often, even if the direction of a trade idea is correct, the timing might be off – which makes the entire trade incorrect.
By committing to a dollar-cost averaging approach, investors avoid the risk that they will make counter-productive decisions out of greed or fear, such as buying more when prices are rising or panic-selling when prices decline. Instead, dollar-cost averaging forces investors to focus on contributing a set amount of money each period while ignoring the price of each individual purchase.
KEY TAKEAWAYS ABOUT THIS STRATEGY:
Dollar-cost averaging refers to the practice of systematically investing equal amounts, spaced out over regular intervals, regardless of price.
The goal of dollar-cost averaging is to reduce the overall impact of volatility on the price of the target asset; as the price will likely vary each time one of the periodic investments is made, the investment is not as highly subject to volatility.
Dollar-cost averaging aims to avoid making the mistake of making one lump-sum investment that is poorly timed with regard to asset pricing.