What is The Meaning of Dollar-Cost Averaging?
Dollar-cost averaging is the recurrent purchase of an asset in regular periods of time, despite the current price of that asset.
The stock market grows around 9% yearly, according to its history. By using this strategy, we are not timing the market (which is a bad idea), but assuring we get the average values of it, reducing the impact of a bad trade due to market volatility.
The stock market has always had its ups and downs during time.
Using the dollar-cost averaging strategy avoids situations like the deposit of a considerate amount followed by a serious decline in the price of the invested asset.
By following the same strategy each week/month/year (the interval of time is really up to you), the investors’ minds will be less worried and be able to be more focused on more important things.
Time Is Still Our Most Valuable Asset
It Won’t Always Work
Least but not last… the strategy obviously only works in a given index.
If we look at the S&P 500 Index, it is easy to see that the tendency is to grow, therefore dollar-cost averaging makes sense as a strategy in this investment as of now.
Now, let’s look at one ETF by iShares representing the emerging market of Latin America:
In this chart, the trend is in a downtrend. Here, the recurrent purchase of this asset in regular periods of time does not make sense. The investors would keep losing money over time unless the trend was reversed.
Since we cannot predict the future, we should at least look into the past (it’s still not a guarantee but it’s something).
Dollar-cost averaging can be a good strategy for people who don’t have so much time to be looking at the stock market all the time.
The level of risk varies depending on the type of investment. If an investor chooses an individual stock, the risk is always higher than that of an Exchanged Traded Fund (ETF).
It is important to always look at the history in the price of the asset in which we want to apply this strategy. Even if it has always gone up, we don’t know the future, it’s all speculation.