Dollar-cost averaging is an effective way to mitigate the impact of volatility while investing in large financial assets. Also known as cost averaging or incremental averaging, dollar-cost averaging helps investors to ride out market downturns and manage their emotions, while promoting disciplined saving.
Dollar-cost averaging encourages investors to invest in smaller sums instead of making one huge purchase of a financial instrument. The strategy allows an individual to invest at regular intervals until the capital is spent.
Why Use Dollar-Cost Averaging?
Following are some of the benefits of dollar-cost averaging:
- Promotes Disciplined Saving
Dollar-cost averaging is a technique that encourages an investor to add money regularly to their investment account. This is a great approach towards disciplined saving. Obviously, there is no guarantee that portfolio value always goes up; a prolonged downtrend might be damaging to the portfolio.
- Ride Out Market Downturns
The dollar-cost averaging strategy allows investors to purchase smaller amounts of investments periodically and thus, helps to ride out market downturns. Managing a portfolio using this technique also enables one to buy more at lower prices enhancing investment returns.
- Manage Emotions
Investing is mostly about managing one’s own emotions. Fear, greed, herd mentality, frustration, impatience can wreak havoc on your returns unless managed properly. Dollar-cost averaging helps investors reduce emotional decision making, potentially enhancing your returns.
Dollar-cost averaging is also a great approach for less experienced investors who do not want to get exposed to market swings. As no one can predict the turns of a market at a given time, this investment technique allows an individual to make multiple recurring contributions and manage the volatility of investments in a more systematic way.
- Improves Liquidity & Flexibility
Since the entire corpus is not invested at one time, this technique also enables one to remain flexible and change course if required. It also enables people to divert funds for other non-financial uses in case of emergencies.