Dollar-Cost Averaging (DCA) is a strategy for acquiring stock. The strategy effectively attempts to minimise the effort (and risk) of trying to ‘time the market’ with lump-sum purchases. The likelihood that an investor, whether beginner or experienced, chooses the optimal time and price to invest in a stock is very low, so Dollar-Cost Averaging is an applicable risk-mitigation strategy for all investors.
Dollar-Cost Averaging involves an investor regularly purchasing stock, over an extended period of time, so that they are exposed to the upside and downside potential of the stock’s price movement. Short term volatility in a stock's price can thus be negated.
Furthermore, the regular purchases should be all the same value to spread the risk evenly. When an investor Dollar-Cost Averages into a stock in this manner they are not trying to buy only when the price is low but are investing regardless of the price. In today's digital age, Dollar-Cost Averaging is incredibly simple to perform as purchases can be set up to be automatic.
Importantly, Dollar-Cost Averaging also helps investors mitigate the risks when investing internationally. This is because, stocks are not the only thing that will typically change in price over time, but so too does the value of one currency against another. Dollar-Cost Averaging can help investors avoid any short-term volatility that often occurs in the forex market in the same way that is works for stock prices.
Two additional benefits of Dollar-Cost Averaging is that is builds a healthy habit of regularly investing while removing the emotional component of investing.
Jill is an investor that is interested in acquiring a stake in Microsoft but is concerned with timing the market. Therefore she has decided to Dollar-Cost Average into the stock at the start of every month, with a budget for 1 share per month.
|Month||Cost of 1 shares US$||Number of shares||Total shares accumulated||Total spent US$||Total value of portfolio US$|
|Average cost per share||243.74|