If you’ve ever found yourself making emotionally driven decisions with your money, you’re not alone. It naturally happens when dealing with money in general, but it’s especially easy to do during times when the market is experiencing downturns, and you see your portfolio declining. This investing strategy can help remove those often counterproductive emotions from investing.
How dollar-cost averaging works
One way to become a better investor is by remaining consistent with your strategy. With dollar-cost averaging, you decide on a particular amount you want to invest, how often you want to invest it, and do it on a set schedule — regardless of what’s going on in the market and the price of the assets you’re buying.
For example, if you get paid biweekly, you could decide you want to invest a certain percentage of your paycheck every two weeks. If you get paid monthly, you might choose to do it then.
How much and how often you decide to invest isn’t as important as the fact you’re remaining consistent and sticking to your investment schedule. You may buy stocks right before they decline; you may buy some right before they increase. Over time, you’re going to do both, but what matters is that you didn’t spend time and emotional energy trying to decide the “perfect time.” You should try to use dollar-cost averaging at all times, but it’s especially helpful to your mental health when the stock market is experiencing high volatility.
If you have a lump sum, it can also help to invest it using dollar-cost averaging instead of all at once. Investing a large chunk of money and then watching it instantly decline can be tough psychologically, so try to avoid a situation where that could happen to you. If you have $10,000 to invest, for example, you could decide to invest $1,000 every 10 weeks, $2,500 every month, or however you see fit.
Don’t try timing the market
No investor can consistently time the market right long term — not me, not you, not even Warren Buffett. Yet if you’re not disciplined, you’ll find yourself trying to do so. If you see stock prices declining during a bear market, it’s easy to say you won’t invest right now, because you’ll be able to get the same shares later at a lower price. But the truth is you never know what will happen with short-time price movements.
Instead of having money sitting around waiting for the “ideal time,” you should be comfortable investing it and trusting in the long-term return potential. There’s a reason conventional investment wisdom says, “Time in the market is more important than timing the market.” You don’t give your money a chance to experience real growth if you don’t invest it.
With U.S. savings account interest rates trailing well behind inflation, money sitting around should be put to work (with the exception of your emergency fund). Dollar-cost averaging helps with that effort.
Dollar-cost averaging happens with a 401(k)
A great example of dollar-cost averaging in practice is with a 401(k) plan. You decide a set percentage of your paycheck that you automatically want to be contributed and invested in your account. For every paycheck, those contributions and investments happen regardless of how expensive your investment elections are.
It’s easy to pay less attention to your 401(k) account, because it’s more of a set-it-and-forget-it vehicle for most people. But behind the scenes, you’re enjoying the core benefits of dollar-cost averaging.