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Dollar cost averaging and how to do it

Posted on | February 22, 2013 | Comments Off on Dollar cost averaging and how to do it

It’s said by investors that the bear market argument always sounds the most intelligent – and never was a truer word spoken. Whenever the market takes a big wobble for some reason, the hindsight economists always seem to emerge from the woodwork saying “I told you so” because, of course, they’re always telling us so.

And these are, unequivocally, fearful economic times, which is part of the reason why short-term lenders like Wonga Canada are prospering.

On the other hand, when we’ve been through a bull-run as world markets generally have since last August, then commentators seem to do the opposite and call the market higher still. Meanwhile, as a private investor, you may be thinking the opposite on nothing more complicated than “the market has risen a lot, so it’s inevitably due for a fall” basis.

One potential way around these bull versus bear problems for the private investor is through dollar cost averaging, so what is this exactly and how do you go about it?

Well dollar cost averaging is a potentially useful investment strategy that can be used to iron out the market’s inevitable peaks and troughs. It also helps take the emotion out of your decisions. Simply put, dollar cost averaging is a form of investing whereby you invest equal amounts of money at regular intervals over specific periods of time or ad-infinitum.

The theory is that you inevitably buy more shares in something when the market is down thereby lowering the total average cost per share of your investment, and gaining from a lower overall cost for the shares you’ve purchased over a long period of time.

In other words, a dollar cost averaging strategy is a kind of admission that none of us ever knows what the market is going to do next – so when it’s down, it’s always going to recover and you’re always going to be buying more units of something on the severest of dips. So it has a lot of merit.

But there are disadvantages. If, for example, you have cash to spare in the middle of a major market slump and you’re felling brave enough to invest it – then strict adherence to a dollar cost averaging strategy precludes you from doing just that.

But perhaps the main disadvantage is in choosing the investment itself. This is, of course, a matter for personal choice and if you aren’t confident in deciding where to invest, then a financial advisor is best-placed to help you spread your investment risk in accordance with your investing objectives and timescales. In this way, dollar cost averaging can be a real boon to the hands-off long-term investors amongst us who haven’t really got the time and/or the inclination and knowledge to be watching the market every day of our lives.

If you’re a real market watcher, though, it can still be a good strategy in ironing out the peaks and troughs and forcing oneself to buy more of our favourite stocks come market rain or shine. This can be great self-discipline in taking the emotion out of things and you will, inevitably, buy more at the lowest points. Whether you’re feeling confident enough to buy more still is up to you – but that isn’t exactly the point of dollar cost averaging.