Investing is challenging, as there are many paths to follow.
Especially for beginners, it is important to understand how the world of investments works and find the best alternatives.
In this sense, there are good strategies that can work, such as dollar-cost averaging, or DCA, which is quite popular in the U.S. See what the technique is and how to use it in your investments.
What is dollar-cost averaging?
DCA is a strategy that divides the investment into smaller installments, applied over time.
Instead of investing a large sum all at once, the investor makes smaller contributions at regular intervals, such as weekly, monthly, or quarterly.
For example, if you have $1,000 to invest, instead of applying it all, you divide the investments into 10 contributions of $100, made monthly.
This way, you buy more units of an asset when the price is low and fewer when it is high.
What are the benefits of dollar-cost averaging?
Reduction of Timing Risk
Trying to predict the best time to invest, known as market timing, is very difficult, even for the most experienced investors.
DCA eliminates the need to get the timing right when entering the market, as the contributions are made automatically and regularly.
Discipline and Consistency
With DCA, investing becomes a habit, as you are spreading the investments over time. This regularity is crucial for those who want to build wealth over time.
Regardless of market conditions, you continue investing, avoiding decisions based on emotions such as fear or greed.
Mitigation of Volatility
Markets are volatile, and asset prices can rise or fall dramatically in short periods.
However, DCA helps reduce the impact of these fluctuations by spreading your investments over time, lowering the risks associated with buying at a price peak.
Accessibility for Beginners
One of the great advantages of DCA is that it does not require large initial sums, making it ideal for those with little to invest.
Even with modest amounts, it is possible to start investing and enjoy the benefits of this strategy.
Additionally, you gain time to learn more about investing and diversify your portfolio.
How to Implement Dollar-Cost Averaging
Choose a Fixed Amount
First, determine how much you can invest regularly without compromising your personal finances.
This amount should be feasible and consistent, as the success of DCA depends on the continuity of the contributions.
This is also a constant in investing, where you need to have realistic expectations.
There’s no point in projecting very high contributions that you cannot consistently maintain in a sustainable way.
Set a Regular Interval
Decide on the frequency of the investments. The most common approach is to make monthly contributions, but weekly or quarterly intervals are also valid, depending on your financial plan.
Select the Right Assets
DCA is particularly effective for investments in index funds (ETFs) or diversified stocks, which offer long-term growth.
These assets are less volatile than individual stocks and align well with the gradual approach of the strategy.
Automate the Process
Many investment platforms allow you to set up automatic contributions. This feature not only saves time but also ensures that you maintain the discipline needed to stick to your plan.
See a Practical Example of the Strategy
Let’s say you want to invest $200 per month in an index fund. In the first month, the price per unit is $50, and you could buy 4 units.
In the second month, the price rises to $60, reducing your purchasing power to 3.33 units. In the third month, the price drops to $40, allowing you to buy 5 units.
After three months, you will have invested $600 and accumulated 12.33 units of the fund.
The average price paid per unit will be lower than the price of the asset in the more expensive months, due to the regular buying strategy.
How to Use Dollar-Cost Averaging Well
DCA is an effective strategy, but it’s not perfect. The limitation is that investing more can yield more.
Additionally, you’ll still be exposed to market risks, which are always present in investments.
That being said, DCA remains a useful tip that, if