When markets are volatile like they are now, dollar-cost averaging – the technique of spreading your investments over time – can be your best friend. Here’s how it works:
Let’s say the price of a stock is at $25, then falls to $15, and then reaches a new high of $27. Now let’s say you had $12,000 and invested it all in that stock on the first day. In this case, you would have bought 480 shares at a price of $25 per share, and would have made a profit of $960. Not bad, right?
But, if you had invested $1,000 every month for a year instead, you’d have bought more shares at a lower price – and drawn a bigger profit. Through dollar-cost averaging, you’d have spread your $12,000 investment out over time, and been able to buy 133 more shares for an average price that would be $5.50 cheaper per share. And your profit would have been about four times higher.
Now of course, if that stock had just gone straight up since your first buy, you’d have been better off buying it all from the start – you’d have gotten the cheaper price and your returns would have compounded more. In that scenario, dollar-cost averaging actually would have meant buying fewer shares at increasingly higher prices over the course of the year. So dollar cost averaging is not always your best option.
But when times are uncertain and volatility is high (like, say, now), dollar-cost averaging makes sense: not only is it likely to generate better overall returns, but it’s also likely to make buying shares a little easier. After all, it’s just less scary to invest $1,000 on 12 different days than $12,000 all at once. And when prices are bouncing up and down, this strategy may help reduce the psychological pressures related to your entry price (“Oh no, I bought at the top; maybe I should sell and buy later”).
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