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Benefits of Dollar Cost Averaging (DCA)
Dollar cost averaging (DCA) refers to an investment concept where you buy a fixed dollar amount of shares on a regular basis, regardless of the share price. In this manner, DCA takes advantage of the share price movements in the stock market. It ensures that you buy more shares when prices are low and fewer shares when prices are high. Over time, as you accumulate more shares when prices are cheaper, you are able to potentially lower the average purchase price per share.
Whilst it is certainly ideal to have a sizeable amount of cash from which to invest, the fact is majority of us don't. Hence, DCA presents an attractive opportunity for individuals who may be interested in investments but need not have substantial amounts of cash to do it.
Individuals who are new to the workforce or are burdened by heavy financial commitments can still choose to ease into investing through DCA. It offers a sustainable and affordable way for individuals to start accumulating shares and gain exposure in the stock market.
Other benefits of DCA stem from its understanding of people's behaviour towards investing. Among which is our fear of losses. Indeed, we tend to be more psychologically affected by losses than by gains. Simply put, the pain from losing money tends to linger, whilst the joy in earning returns tends to be short-lived.
This is where the simple structure of DCA can help reduce such fears. By investing an equal amount of money into shares on a regular basis, you are able to lower the average purchase price per share. This can be comparatively lower than the average share price over the same period of time. Seen in this manner, DCA helps to shield you from potential long term losses, making the idea of investing more palatable.
Once you have made the decision to invest, typically the next concern is the timing of the investment. Unpredictable price movements in the stock market tend to generate much anxiety that may affect your decision to invest. The mental "what-ifs" start coming to mind and often results in a "wait and see" attitude. Eventually, the market moves for better or worse, and the same cycle of doubt and hesitance begins again.
DCA provides a way to overcome such emotional hurdles. By gradually investing in the stock market, DCA places smaller amounts at risk at a time. Hence you can take solace that any sudden drop in stock prices will not cause as huge a loss as if you had your entire lump-sum invested.
While emotions can result in delayed actions, it can also lead to drastic moves as well. This is especially observed during a declining market when share prices are decreasing. Typically, we tend to be overly-pessimistic during these periods and find it difficult to stay invested, believing that the recent decrease in prices will continue into the future.
However, DCA prevents such knee-jerk reactions and keeps you from completely terminating your investment plan. This keeps you invested in the market so that you are able to benefit from the market recovery later on.
In all, the simplicity of DCA helps you overcome certain recognized behaviour which would otherwise have kept you from investing. It offers an affordable, sustainable and comfortable way for new investors to ease into the stock market without incurring the anxiety that comes from having too much invested in a short period of time. It is thus the more practical choice among new investors and investors who may not have the time to actively monitor the performance of the stock market.
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