Last time we chatted about time in the market, not timing the market. Today we’re going to talk about dollar-cost averaging (DCA).
When we talked about timing the market we mentioned the volatility. Let’s take this year for example, below is a chart of the S&P 500 performance year to date, as you can see there is a lot of market fluctuation.
There are two theories when it comes to when to investing:
Lump Sum Investing - If you have a lump sum to invest, do it all at once because if you’re investing for the long run you don’t need to worry about the short-term volatility. It also allows you to start taking advantage of the markets growth for all of your funds immediately vs. spreading it out over a year and having money sitting in cash waiting to be invested.
Dollar-Cost Average (DCA)- Invest a consistent amount of money on a consistent schedule so that you can take into account all of the market fluctuations. On all investment platforms, you’re able to set up automated investments to make the same transaction week after week. You don’t need to physically make the transaction weekly.
As an example, let’s say you wanted to DCA Apple stock and you started to invest on the last Friday of every week in April. The cost per share when you buy would be the following:
April 5: $169.58
April 12: $176.55
April 19: $165.00
April 26: $169.30
May 3: $183.38
May 10: $183.05
May 17: $189.87
That’s a 15% difference from the lowest price to the highest. And if you were investing weekly, you’d be able to take into account all of those price fluctuations. Your investment would be the average of the entire period you’re investing.
Dollar-cost averaging can be a great way to start investing if you feel nervous and want to start small or are worried about a market downturn. It’s also a great way to start if you have limited funds. You can invest as little as a $1. You don’t need to buy an entire share of something. And it’s also a good way to invest in riskier assets, like cryptocurrency.
If you have a retirement fund that you contribute to per pay period or regularly contribute to a non-employer retirement fund then you are naturally dolla-cost averaging. Many self-employed people wait until right before the end of the tax year to make a large contribution, which would be lump sum investing.
I’m not here to tell you what option makes the most sense for you, just to give you the information so you feel empowered to make the best decision for yourself. I will say that most people I work with, who have never invested before, feel more comfortable starting with DCA. One more thing to consider, investing in individual stocks can be riskier than buying into an index or mutual fund (which is a collection of many stocks so it’s naturally diversified and something we’ll talk about soon) so that is something to consider with DCA or lump sum. And of course, lump sum investing requires that you have a chunk of money to invest, which many people do not. The biggest barrier to starting something new, like investing, is often psychological so having the ability to test the waters in a way that feels comfortable to you is important, and dollar-cost averaging can be a perfect entry point.