I have heard arguments both for and against Dollar-Cost Averaging, but I use it and have found it to be quite useful as passive investing strategy. I will explain what it is and why you should use it for investing, especially if you have limited knowledge of the markets.
What is Dollar-Cost Averaging?
In simple terms, Dollar-Cost Averaging is a way of buying a stock index (think S&P 500) or an individual stock with the same amount of money at regular intervals (every month or every quarter) so as to reduce the risk that the stock market might go down.
As a new college graduate, you may be hearing people say you should be investing in your company’s 401K or some other sort of investment vehicle. But assuming you figure out how to do that, what should you invest in?
With the abundance of media nowadays, I’m sure that you know what the stock market is and have seen a stock ticker on TV. Let’s say you see that GE is priced at $20. What does that mean to you?
Unless you’ve been tracking the stock market for a while, that $21 is just a number. It has no meaning to you. You may know the number of stocks outstanding, etc and so can calculate the “Market Capitalization” of a company, but does this really mean anything to you? If you don’t understand what I’m talking about, don’t worry.
Now let’s say you invested $1000 into GE so you have 50 shares of GE stock ($1000/$20 per share) in January. You don’t check your stock for a few months and come back to see the value of your investment in October (10 months). Oh no! The share price dropped to $15 so your investment is now worth $750 (50 shares * $15 per share). You just lost $250!
Enter Dollar-Cost Averaging. Let’s say that instead of investing the $1000 all at once, you decided to invest $100 per month during those 10 months. Let’s look at the example below:
DCA doesn’t always give a better return than investing all your money in the beginning, especially when dividends are factored in, but it does give you a simple way to invest your money without having to worry when the market is going to take a dive. In fact, if the market does dive, you’ll be buying more shares for the same amount of money which will amplify the gains when the market does turn around.As you can see, with the smaller contributions every month, you actually only lose $38!
To learn more about the benefits and risks of DCA, just search Google. There are plenty of articles about it.
How to Start Dollar-Cost Averaging?
Investing along can be a daunting task when starting out, but it can become even more complex when trying to learn how to invest with DCA. First you need to find a broker. Search Google for one of these, or look below, and maker sure they support Dollar-Cost Averaging investing, sometimes called Systematic investing.
Once you have an account open, you must fund the account, making sure that the account will fund itself automatically for the interval you want to use DCA for, and then start using DCA.
Brokers who Support Dollar-Cost Averaging
- TD Ameritrade – My favorite. They have quite a few index mutual funds that have no transaction/commission cost.
- Setting up DCA: https://wwws.ameritrade.com/html/help/help_fundhelp.html#setup_systematic
- Form: https://www.tdameritrade.com/retail-en_us/resources/pdf/TDA100.pdf
- Recommended funds:
- POMIX – Stock Market Index Fund
- DBMIX – Bond market Index Fund
- DISSX – Small-cap
- Scottrade – Scottrade unfortunately does not have free systematic investing. They charge you $2 for every trade.
DISCLAIMER: The investing ideas suggested in this article are informational only and I do not hold any responsibility for losses when using the method above or any other investing strategy. I currently hold positions in POMIX, DBMIX, and DISSX with no plans of selling in the next 60 days.