One of the biggest problems in today’s markets is the sheer volatility that we are seeing on a regular basis. Getting in at the right price on stocks, even great companies may be a challenge when only shooting from the hip. The dollar cost averaging stock strategy is a great approach for people new to stock investing that minimizes risk and trends towards sound profitability – especially the longer it is used. What is important to understand is that you are most likely going to save your money on a weekly, bimonthly, or monthly basis, so why not minimize the price losses of getting in on the temporary highs by dollar cost averaging your stock purchases.
The dollar cost averaging stock strategy minimizes risk because it reduces the difference between the initial investment and the current market value over a long enough timeline. This is accomplished by making fixed investment amounts at predetermined times. The point is to remain committed to this investment for years and not to allow fluctuations in price to affect your buying strategy.
Knee jerk responses are common with stock investments, especially for beginners. One bad earnings report can send stock prices tumbling and cause investors to panic. This causes a sell-off that further lowers prices. If a person were to keep their stock and still continue buying at regular intervals, the average price of the stock should continually approach the current market value at the time of purchase at each interval. Temporary fluctuations in pricing should even out. While the stock price may be lower than the initial investment value, the ability to acquire more shares at a lower price means that the short-term decrease in average stock price should be balanced out when the share price increases.
The very first step in planning to use this strategy is determining how much you can realistically afford to invest over an extended period of time. This is very important because the strategy will not reduce risk of loss effectively unless the investment amount is consistent. You will not insulate yourself against losses as effectively when a large initial investment is made and then followed by increasingly smaller amounts. In such a scenario, the gap between the average stock price and current market value will be larger and the risk for loss greater.
The second step would be to look for solid companies and investments to follow and pour into over the long term. When investing with this strategy, you want to find a long-term investment that will be a good buy for years to come.
Finally, pick an interval that you can be consistent with for years into the future. A weekly interval will work but it is probably best to make it monthly or even quarterly. Longer intervals are better because they reduce the expense of multiple transaction fees and also allow you to buy larger numbers of stock with each purchase.