There’s a common facet of life that underscores every major success. It’s the thread that ties together the Olympian and the award show winner as much as it links the stellar student and even the daily exerciser. It’s consistency. As a society, we know this is true—there are hundreds of miles leading up to that marathon’s finish line, countless hours of studying behind a summa cum laude, and dozens of failed auditions behind that glittering trophy. This isn’t a secret. But you know what it is? It’s boring.
Dollar-cost averaging may be one of the most straightforward financial concepts to learn, but it’s also could be the most effective when it comes to long-term investing.
What is dollar-cost averaging?
Dollar-cost averaging is an investment strategy that involves investing a fixed amount of money in the same funds or stocks at regular intervals over long periods of time. It might seem like a crazy idea, but if you have an employer-sponsored 401(k) retirement plan, you’re already using this strategy.
When you set up recurring investments, you average out your purchase price over time and help prevent all of your purchases from going through at a high point for stock prices. It’s impossible to time the market—the experts say don’t even bother trying. Instead, purchase throughout the year and the price you’ve paid per share will be averaged out over the highs and lows of that whole 12-month period.
For example, if a stock is trading at $100 per share in January, and then continues to rise by 10% each month, it will trade at almost $285 in December. When was the right time to jump in and buy that stock and how would you know? Using dollar-cost averaging, you could have invested $150 each month into purchasing stocks, or fractions thereof, and averaged out your price all of the monthly prices added up and then divided by 12. In this case, $162.
Now consider that versus if you had just plunked down $1,200 to make a bulk stock purchase in December. That would mean paying $285 per share and therefore buying fewer of them.
When does dollar-cost averaging work?
Dollar-cost averaging works best when we’re operating in an active, fluctuating market (AKA most of the time). The reasons that it works well are equal parts mathematical and psychological. The numbers speak for themselves in the example demonstrated above. Math is math and numbers are numbers, there’s no wiggle room in 2+2. But our brains don’t work that way all the time. The psychology behind spending and investing is complex thanks to something called cognitive bias.
One common cognitive bias that comes into play with investing is status quo bias. The status quo bias is evident when people “prefer things to stay the same by doing nothing or by sticking with a decision made previously.” This is evidenced in finance by, say, a person sticking with the same financial institution because “it’s the one they’ve always used” or the only one they know anything about. If you’ve been investing with the same platform for years despite their high fees—get out! Take a few hours to research your options and find a better option.
Dollar-cost averaging takes the emotional labor out of investing. You don’t need to think if this exact move is the right one to make based on the market and its timing, you just invest. It also fuels the fire of a long-term investing mindset. Once you commit to investing in regularly timed intervals in an effort to build wealth over time it may impact other areas of your life.
One of the most famously successful investors, Warren Buffett, sticks to value investing. One of the tenents of value investing is to keep your cool. Don’t let fear and greed change your strategy and never, ever, sell in a panic. The market moves, that’s what it does. By letting your emotions run high and selling when prices drop you’re going against the principals of long-term value investing. You do not want to buy high and sell low.
Dollar-cost averaging removes this as an option.
When doesn’t dollar-cost averaging work?
Doll-cost averaging means dividing your money into smaller portions and investing gradually and evenly over time. That way, you theoretically avoid the danger of investing all of your money on a particularly bad day in the market. But what happens if you use this strategy during a positive year, especially one that doesn’t have any big drops? You could miss out on some serious upside. Missing out on positive market returns can compound over time.
That being said, time in the market always beats timing the market. There’s just no way to know that a year is going to be a particularly good or bad one. More likely than not, it will just average out to be a pretty OK year. In aggregate and over time, the stock market has returned 10% annually to its investors, on average.
How to start a dollar-cost averaging strategy
To begin a dollar-cost averaging strategy, you need to do four things.
Choose an investing platform
Online platforms like Public offer access to a greater number of stocks than you might find with an IRL broker. There’s no minimum to start and Public’s unique social aspect makes it possible to collaborate with other investors and strengthen your financial literacy as you go.
Set your investment budget
Decide exactly how much you can invest each month. It’s important to make certain that the amount committed makes sense for your lifestyle and will be easy to maintain monthly. A popular budgeting method is the 50/30/20 Rule. Using this method, 20% of your after-tax income is dedicated to savings and investments. Funding your emergency accounts, investing in the stock market or mutual funds, and contributing to your IRA all count here. Emergency savings accounts should either be in place or in progress before you begin investing.
Select your investments
Public organizes curated themes of stocks that align with the way you actually experience companies in everyday life. There are environmental, tech, SaaS, and even blue-chip portfolios. Take your time and choose what works best for you now—and down the road. These are long-term investments.
At regular intervals—weekly, monthly, or quarterly— invest that money into the securities you have chosen.
Fractional shares and dollar-cost averaging
Fractional share purchasing and dollar-cost averaging go hand-in-hand. Public makes it possible to assemble a portfolio of companies you believe in by offering the ability to buy stocks in fractional shares, AKA slices. This means that investors don’t pay the full share price of public companies, but invest what they’re able to. The shares are divided up into slices, making it possible for you to invest $20 and buy a slice of a stock that costs $100 in full.
The bottom line
Investing in line with your budget is not only possible but may actually be the better way to build wealth. By using a dollar-cost averaging strategy you are able to smooth out the stock price highs and lows over time. Some of your stocks will be purchased on the dip and some will be purchased at a high point, that’s the beauty of dollar-cost averaging. Using a platform like Public makes it simple to invest regularly in companies that align with your values and your budget.