What is Dollar Cost Averaging and if you should do it!
The investing world can be a very scary place for a new investor. There is a lot to learn when you begin your investing journey. You will learn about investing strategies, business structures, taxes, stock analysis and a whole lot more.
Most new investors do not start out with a lot of money to invest. So they would be able to employ one of two different strategies or a combination of the two. Over the years, I have found that some strategies may work better than others. It is all very dependent on the situation.
Let’s take a look at these two strategies and then you will be able to decide for yourself.
Strategy #1: Big Purchases
The first strategy is pretty straight forward. You save as much money as possible over a lengthy period of time like 6 months or a year. Once you reach a large amount you then deicide to invest the money into 1 big purchase. So you are able to acquire a lot of shares in the company, in a very short amount of time but you will be buying all of these shares at the same cost basis. Not to mention the fact that it took you a whole year to save up that amount of money.
I employed this strategy a lot more when I first began investing because at the time you had to pay a trade commission fee for every trade that you made. As a beginning investor, I felt like I needed to minimize this fee as much as possible and my way of doing that was to save up and make bigger purchases.
Strategy #2: Dollar Cost Averaging
The second strategy is another good strategy and it tends to be the one that I have been using more of lately.
In dollar cost averaging, you would select a certain amount of money to invest in that stock over a shorter period of time like a day or a week. By using this strategy you would not have to wait a full year to save up money to invest, you would be able to begin investing immediately.
By making these smaller investments sooner, you would also be able to capture several dividend payments on your way to that one year mark. If you have a dividend reinvestment plan setup on your account then you will be reaping the benefits of compounding dividends over the course of that year as well.
Plus since you are making a lot of smaller investments you will not have the same cost basis on all of the shares. Over time the price of the stock will go up and down. As you are making these purchases, some of them will be below your cost basis and some of them will be above your cost basis.
By using this strategy, you are dollar cost averaging into the position instead of trying to time the market and to make a large purchase at a low price all at one time.
There is no perfect way to invest. I have used both of these strategies at different times. Currently, I am strengthening 2 of my stock positions in BP and Verizon by making bigger purchases while at the same time I am dollar cost averaging my position of Bitcoin and XYO tokens in the crypto space.
It is 2 different strategies but I have been very happy with the results so far.
When is the right time to utilize which strategy will totally be up to you as the investor because only you will truly understand the positions in your portfolio. I would love to hear your thoughts if you think that there is a right or a wrong time to use dollar cost averaging.
As always I look forward to reading all of your comments and questions, until then….. happy investing!
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