by Want to learn the investment strategy that produces the best results and takes the least amount of work? That strategy, often times overlooked, is dollar cost averaging. In this post I’ll cover several dollar cost averaging benefits and how to implement the strategy in your investment account.
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Buy more when prices are low
Like a roller coaster, the stock market will experience ups and downs.
With dollar cost averaging, you will devote the same dollar amount to buying an investment in regular intervals. For example, you can dollar cost average to purchase $500 worth of an index fund every month. If the price of the index fund drops in price one month, you’ll still devote $500 on your purchase, but you’ll end up buying more shares than the previous month. Score!
Buy less when prices are high
Similarly, if the price of the index fund rises in price one month, you’ll still devote $500 on your purchase, but you’ll end up buying less shares than the previous month. When things are expensive, it seems like a good idea to buy less of it. Double score!
Take Emotion out of Investing
Humans are notoriously horrible at market timing.
Data has shown time and time and again that people have a horrible track record at successfully beating the stock market. In fact, only 8% of professionally managed large-cap funds outperformed the S&P 500 after 15 years!
Remember that feeling when a stock you had your eye on had risen in price? If only you had purchased it when it was 20% cheaper. But now you fear that you’re missing out a potential run. So you’re just going to purchase it anyway. Whammy.
You just purchased the stock and expect it to go UP UP UP! But within a month, the stock drops in price by 20%. How can this be? It was supposed to only go up! You are overcome with fear and sell in panic. Double whammy.
You bought when prices were high. Whammy.
You sold when prices were low. Double whammy.
Dollar cost averaging takes the thinking and emotion out of investing. Being consistent with your investing and utilizing dollar cost averaging helps you buy more when prices are low and buy more when prices are high, helping you grow your investments and get your closer to financial freedom.
Dollar Cost Averaging Example and Results
You might be thinking… sure, it all sounds good in theory. But does it actually produce good results?
In my research I came across an article that compared three people:
- Brittany Bottom who correctly predicted the exact bottom of four stock market crashes and invested all of her savings on those days
- Tiffany Top who invested her savings during market highs
- Sarah Steady who utilized dollar cost averaging to invest the same amount every month
They each invested the same amount, $96,000, into an index fund over a period of 40 years.
Who had the best results? Surprisingly, and almost counterintuitively, Sarah Steady’s dollar cost averaging strategy produced better results than Brittany Bottom’s buy low strategy.
The author of the study used real stock market data and you can check out his post here.
How to set up Dollar Cost Averaging
It is extremely easy to implement the dollar cost average strategy.
In any investment account, whether it be in your 401(k) or your brokerage account, you can set up automatic investing.
You’ll set exactly how much you’d like to invest, the frequency, and when you want to start. In some accounts, you can choose to invest monthly, semi-monthly, or even quarterly.
Here’s what it looks like in my Schwab account when setting up dollar cost averaging purchasing of the Schwab S&P 500 Index Fund:
Bottom Line
There are three very real dollar cost averaging benefits. When you dollar cost average, you buy more when prices are low, buy less when prices are high, and avoid making emotional investment mistakes.
Dollar cost averaging is by far the easiest strategy to use and is extremely easy to set up in your account.
Dollar cost averaging is the foundation of my investment strategy. What’s yours?
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