You may have heard of the term dollar cost averaging (DCA). In this article we cover its meaning, as well as the advantages and disadvantages of using this investing strategy.
The DCA strategy involves buying a given financial product (shares, ETFs, etc.) at regular intervals for a given amount. With this strategy, the amount to be invested is set by the person investing. On the date of purchase, this amount is used to buy the selected product at its current price.
This means that if the price of the product is low, more of it will be purchased; if it is high, fewer units will be purchased. Over the long term, this leads to an average purchase price that gives the DCA its name. This method is often used for automated investments.
The main impact of the DCA is to minimise the effects of short-term market fluctuations on investment. Depending on the level of the product at the time of purchase, the quantity acquired may be greater or lesser, but over the long term the purchase price remains balanced.
The underlying assumption for this investment strategy is that the financial product purchased would increase in value over the long term. However, this growth is not necessarily uniform, and there are always occasional rises and falls. Investment in DCA limits the effects of these variations, and tends to optimise the money invested.
DCA investment therefore removes the emotional aspect of investment and turns it into a more pragmatic process. This type of method can be used, for example, as part of an ETF savings plan.
Depending on your investing profile, your relationship with money and your available funds, the DCA may or may not be a good investment method. Below we explain the main advantages and disadvantages.
One big advantage of the DCA is the time it saves you: you don't need to keep a close watch on the markets in order to buy financial products at the best time, at the risk of missing out on the lowest purchase price and losing dividends by investing too late. This method is therefore ideal if you are new in the investing world.
Using the DCA to start investing in the stock market is also a good way of investing small sums at regular intervals. For example, part of your salary to create capital for your retirement.
Finally, the DCA method can limit investment risk by reducing the effects of market volatility. This method can, for example, be adapted to certain products such as cryptocurrencies.
The DCA strategy is not for everyone. If you already have experience in the capital markets, are looking for short-term gains and are aware of the risks, it might be more interesting for you to buy and sell financial products on an ad hoc basis, as investing this way can also be more stimulating and less mechanical than DCA.
If you have a large sum of money at your disposal, such as as a result of a bonus or inheritance, it may be more profitable to invest the entire amount in one lump sum rather than in instalments using a strategy such as dollar cost averaging. Alternatively, you might consider investing half the amount in one lump sum and the remainder in instalments using DCA. In this case, your individual circumstances, such as risk aptitude and time horizon, will be critical in the decision.
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