Dollar Cost Averaging: How to Smooth Out the Ride and Increase Your Returns

Dollar cost averaging is a strategy that is used by many investors to manage their risk when investing in stocks or other securities. The basic concept is to invest a fixed amount of money at regular intervals, regardless of the price of the investment. This can help to reduce the risk of investing all of your money at once and instead spread it out over time.

One of the biggest benefits of dollar cost averaging is that it can help to smooth out the ups and downs of the market. When you invest a fixed amount of money at regular intervals, you are buying more shares when the price is low and fewer shares when the price is high. This can help to reduce the overall cost of your investment and increase your returns over time.

Another benefit of dollar cost averaging is that it can help to reduce the emotional stress of investing. When the market is going up, it can be tempting to invest more money to try and take advantage of the gains. However, when the market is going down, it can be easy to panic and sell your investments at a loss. By investing a fixed amount of money at regular intervals, you are less likely to make impulsive decisions based on short-term market movements.

To give an example of dollar cost averaging, let's say you start investing $100 per month in a stock that is currently priced at $100 per share. To keep it simple, over the next 3 months, the market experiences a downturn and the stock's price drops to $80 per share. Because you are using the dollar cost averaging strategy, you are able to purchase more shares for your money in the second month. For example, in the first month you purchase 1 share, but in the second month the share price drops to $80 and you purchase 1.25 shares.. By the third month you the value of the share rebounds to $100 and you purchase one more share. Your total invested is $300, the value of the shares never exceeds the price at the date of your original purchase, but the value of your account is now $325 because you were able to buy more shares in a down market when the shares were essentially "on sale".

Alternatively, let's say you invested the entire $300 on day one. In month two you will see your account value drop 20% or $60, in month three you are back to the same $300 you started with.

In this scenario, dollar cost averaging helped you to take advantage of the market downturn and purchase more shares for your money. As the market recovered, your investment in the stock also increased in value. This is a simple example of how dollar cost averaging can help you to reduce risk and increase your returns over time.

In conclusion, dollar cost averaging is a valuable strategy and valuable tool for all investors to consider. It helps to reduce the risk, smooth out the ups and downs of the market, and reduce the emotional stress of investing. By investing a fixed amount of money at regular intervals, you are more likely to make smart decisions and increase your returns over time, and the great thing is, you don't need a fortune to get started!