Dollar-cost averaging is a popular strategy for building investment positions over time. It refers to the practice of building investment positions by investing fixed dollar amounts at equal time intervals, as opposed to simply investing a lump sum all at one time.
If you want to invest $20,000 into Apple stock, instead of investing all of the money at the same time, you invest $2,500 on the first day of the month for the next eight months, slowly building your full position.
No matter what the markets are doing, the invested amount never changes. Rather than trying to time the market, you buy in at a range of different price points over time.
It’s easy to imagine scenarios in which a lump-sum purchase can beat dollar-cost averaging. But in general, dollar-cost averaging provides 3 main benefits that can result in better returns. Its good when you want to:
- Avoid bad market timing
- Take emotions out of investing
- Think long-term
In other words, dollar-cost averaging saves investors from their psychological biases. Investors usually swing between fear and greed, as they are prone to making emotional trading decisions as the market moves rapidly.