One question I get all the time when markets are as volatile as they have been this year is what should I be doing?
One question I get all the time when markets are as volatile as they have been this year is what should I be doing?
You have probably heard about the risks of timing the markets a thousand times over.
The fact is, that over the long run it is practically impossible to time the market correctly and will more than likely cause more harm than good.
So, what can we do to better ourselves for the long term when markets are choppy?
The answer is Dollar Cost Averaging.
Dollar cost averaging, or DCA, is a systematic approach to investing where you invest money in equal portions, at regular intervals, regardless of which direction the market is moving.
What this does is allow you to get money invested while smoothing out some of the risk over the long term.
This is because you are buying more when asset levels are lower and less when they are higher. Here is an example of how it works:
Let’s say you have $5,000 to invest and you identified a stock you want to buy. Rather than buying $5,000 at once you elect to invest $1,000 a month into the stock.
| Trade date | Trade amount | Stock price | Shares bought |
| January 15 | $1,000 | $20 | 50 |
| February 15 | $1,000 | $21 | 47.61 |
| March 15 | $1,000 | $18 | 55.55 |
| April 15 | $1,000 | $19 | 52.63 |
| May 15 | $1,000 | $21 | 47.62 |
Using DCA as a Risk Management Tool
In a perfect world, you would buy and investment low and sell it high. But that is not the way things usually work in the long run. The reality is that in the short term the market can be highly volatile and nearly impossible to time.
DCA will help mitigate some of the effects of investor psychology which can negatively impact even the most experienced.
With a dollar-cost averaging approach, you may avoid making a counter-productive decision due to emotions like fear or greed (like buying more when prices are going up or panic selling when prices are going down).
Moreover, dollar-cost averaging might be appropriate if you think there is a possibility that your investment opportunity may decline over the short term (to some extent), but you believe it will rise over the longer term.
Potential Drawbacks
Like most strategies there are potential drawbacks. One is that if the asset does nothing but go up you will miss out on some of the gains. Another is that leaving money in cash that bringing little to no return can be a risk.
Conclusion
Dollar-cost averaging only makes sense if it aligns with your investing objectives. If you are investing in a stock or other asset because you like its long-term prospects, and have decided on an amount to invest, then making a lump-sum investment when you make that decision may be the right tactic.
As with any investment decision you make, you should determine if dollar-cost averaging makes sense for both the individual position you are considering using this strategy for, as well as for your overall investing objectives.
If you would like to discuss DCA as a strategy, please feel free to set up a call using my calendar.
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