How does dollar cost averaging work? | Strategy - Degiro

Dollar cost averaging is a strategy in which investment positions are built by investing equal sums of money at regular intervals, regardless of the asset's ... Forabetteruserexperienceandsecurebrowsing,pleaseupgradetothenewestversionofInternetExplorerorotheralternative. Login Openanaccount Fees Fees ETFCoreSelection CostCalculator Openanaccount Investing Invest BuyingETFs Buyingstocks Buyingbonds Buyingfutures Buyingoptions Buyingstructuredproducts Buyingfunds Platform TradingPlatform App BrokerAwards Safe&Reliable Markets Markets Exchangeopeninghours Exchangeclosingdays Knowledge Knowledge Investor'sAcademy Investor'sAcademy Whatkindofinvestorareyou? Whatisabroker? Basicfinancialproducts Complexfinancialproducts Whatdeterminesthepriceofastock? Choosingyourfirststock Ordertypes Spreadingriskisthekey Thinkingahead What’syourplan? 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Dollarcostaveragingisastrategyinwhichinvestmentpositionsarebuiltbyinvestingequalsumsofmoneyatregularintervals,regardlessoftheasset’spriceorwhatisgoingoninthefinancialmarkets.IntheUK,thisstrategyisreferredtoaspoundcostaveraging.Theseregularinvestmentscanbeintermsofafixedamountofcurrencyorafixednumberofshares.Theintervalscanbeweekly,monthly,yearlyorwheneversuitsanindividual’sinvestmentplanthebest. Theideabehindthisstrategyisthatwhenpricesarehigh,youcanonlyaffordacertainnumberofshares.Whenpricesdrop,youcanpurchasemoreshareswiththefixedamountyouareinvestingineachperiod.Then,whenthemarketrecovers,youbenefitfromhavingmoreshareswhenyouboughtthematalowprice. Howdoesdollarcostaveragingwork? Togetabetterunderstandingofhowdollarcostaveragingworks,wewillworkthroughahypotheticalexample.Saythatyouinvest$100permonthintoanindexfundforfivemonths.Assharepricesvaryateachinterval,youreceiveadifferentamountofshareseachtimewhenyouinvest$100,asillustratedbelow: Month Investment Shareprice($) Unitspurchased Sharestotal Totalvalue 1 $100 5 20 20 $100 2 $100 3 33 53 $159 3 $100 2 50 103 $206 4 $100 6 17 120 $720 5 $100 6.5 15 135 $878 Totalamountinvested= Averageshareprice= Totalunitspurchased= Investmentvalue P/L $500 $4.50 135 $878 $378 Note:numbersarerounded Aftermakingmonthlycontributionsofequalamounts,yourtotalinvestmentafterfivemonthsis$500.With135sharesattheendoftheperiod,theinvestmentvalueis$878.Therefore,youwouldhaveprofited$378. Itisimportanttohighlighttheaveragepricepersharecomparedtotheaveragepricepershareyouenduppaying.Inthiscase,theaveragesharepriceattheendofthefivemonthswas$4.50((5+3+2+6+6.5)/5)).However,theaveragepriceyoupaidpersharewassignificantlylowerat$3.70($500/135shares). Ofcourse,itisnottosaythatutilisingthisstrategywillalwaysresultinaprofitnoritistosaythatitwillprotectinvestorsfromfallingshareprices. Dollarcostaveragingvs.timingthemarket Anopposingstrategytodollarcostaveragingistotimethemarket.Timingthemarketisaninvestmentstrategywherebyinvestorsattempttobeatthestockmarketbypredictingitsperformance.Itisanactivestrategythatfocusesontheshorttermandrequirescloseattentionandmonitoringofthemarket.Someinvestorschoosethisapproachbecauseiftheygettheirtimingright,theycangenerateabove-averagereturns.However,perfectlypredictingthemarketscontinuouslyisimpossible. Dollarcostaveraging,ontheotherhand,isapassiveinvestmentstrategy.Thisstrategydoesnotrequireasmuchattentiontothemarket,asyoumakeinvestmentsofthesameamountofmoneyonaregularbasis.Also,ratherthanenteringandexitingdifferentpositions,youbuildapositioninastock,bondorfund. Advantagesofdollarcostaveraging Adollarcostaveragingbenefitisthatittakesemotionalfactorsoutofinvesting.Sinceyouareregularlymakinginvestmentsnomatterwhatthemarketconditionsare,emotionsareeliminatedoutofthedecision-makingprocess.Forexample,ifthemarketisonadownswing,someinvestorsmightpanicandsellofftheirholdings.Withthisapproach,itcanbeseenasanopportunitytobuyatlowprices,keepinginmindthatthisstrategyistypicallyusedforlongterminvestmenthorizons. Asdemonstratedintheaboveexample,thisinvestmentstrategycanalsohelptoaverageoutsharepricefluctuationsandreducethepriceyoupaypershare.Sinceyoubuymoreshareswhenpricesarelow,thisgenerallycreatesascenariowheretheaveragecostpershareyoupayislowerthantheaverageshareprice. Additionally,thisstrategyenablesinvestorswhodonothavealargelumpsumofmoneytobuildapositioninacertainproductovertime.Forexample,someinvestorsmighthave$10,000toinvestatonce.Whereas,otherindividualsmightnothavesuchasumatacertaintime,butcanusethisstrategytobuilduptoapositionworth$10,000. Disadvantagesofdollarcostaveraging Likeanyotherinvestmentstrategy,dollarcostaveraginghasitsdrawbacks.Forone,someexpertssaythatmakinguseofthisstrategycanhavelowerreturnsincomparisontoalumpsuminvestment.Theargumenthereisthatstockmarketstendtoriseovertimeand,therefore,leavingmoneyoutofthemarketcanmissoutonbiggains. Anotherpotentialdisadvantageofthismethodismorefees.Ifyouareinvestingwithabroker,youtypicallyhavetopaybrokeragefeesforthetransactionsthatyoumake.Therefore,ifyouareinvestingatregularintervalsversusonelumpsum,youmayenduppayingmorefees. Risksinvolved Choosingtouseadollarcoststrategycanberewarding,butitisnotwithoutrisk.AtDEGIROweareopenandtransparentabouttherisksthatcomewithinvesting.Beforeyoustarttoinvest,thereareanumberoffactorstoconsider.Ithelpstothinkabouthowmuchriskyouarewillingtotakeandwhichproductsmatchyourknowledge.Additionally,itisnotadvisabletoinvestusingmoneythatyoumayneedintheshorttermortoenterintopositionsthatcouldcausefinancialdifficulties.Itallstartswiththinkingaboutwhatkindofinvestoryouwanttobe.Youcanreadmoreabouttherisksofinvestingonourdedicatedriskpage. Theinformationinthisarticleisnotwrittenforadvisorypurposes,nordoesitintendtorecommendanyinvestments.Investinginvolvesrisks.Youcanlose(apartof)yourdeposit.Weadviseyoutoonlyinvestinfinancialproductsthatmatchyourknowledgeandexperience. RelatedLessons Investor'sAcademy Whatisabroker? Stockexchange Broker Orderexecution Fees Investor'sAcademy Basicfinancialproducts Shares Bonds Funds Trackers Investor'sAcademy Complexfinancialproducts Options Futures Leveragedproducts Investor'sAcademy Whatdeterminesthepriceofastock? IPO Pricemovement Marketcapitalisation Bid&ask Startinvestingtoday Joinmorethan2millionclientsthatplacetheirtrustinus. Openafreeaccountnow Partners&Providers Note:Investinginvolvesrisks.Youcanlose(apartof)yourdeposit.Weadviseyoutoonlyinvestinfinancialproductswhichmatchyourknowledgeandexperience. Note:Investinginvolvesrisks.Youcanlose(apartof)yourdeposit.Weadviseyoutoonlyinvestinfinancialproductswhichmatchyourknowledgeandexperience.