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Tuesday, October 14, 2008

What is Dollar Cost Averaging?

Dollar-cost averaging (DCA) is a wealth-building strategy that involves investing a fixed amount of money at regular intervals over a long period. Now, most of the time, we hear this term being associated with mutual fund investment. Is it only good for that?

Dollar-cost averaging is simply an investing method of a fixed dollar amount at pre-determined intervals.It can be used in stocks investments as well as mutual fund investments or just any other kind of investment. Yes, you can apply it on real estate investment too, if you want. However, the problem would be the amount of cash that you would need to apply this strategy. For example, let's just say you bought a property at 200,000. Can you invest the same amount on a regular or monthly basis? That would be ridiculous!

But it would be an excellent strategy to be used on mutual fund investment or in the share market. The amount of money invested at each interval remains the same over time, but the number of shares purchased varies based on the market value of the shares at the time of a purchase. When the markets are up, you buy fewer shares per dollar invested due to the higher cost per share. But frankly speaking if the market is on the uptrend, it would not be advisable to invest, right? However, usually investors in mutual funds are known as passive investors, therefore they just let their investment grow over the years and probably they don't have the time to monitor their investment as well. When the markets are down, the situation is reversed and you purchase a greater of number of shares per dollar invested. It's a strategic way to invest because you buy more shares when the cost is low, so you get an average cost per share over time, meaning you don't have to invest the time and effort to monitor market movements and strategically time your investments.

It enables even low-wage earners and folks with tight budgets to invest a minimum amount that they are comfortable with on a regular basis.It cultivates investors to get into the habit of saving, and these small amounts can really add up over the course of a lifetime thanks to the power of compounding.

Now, the next common question would be - 'Can't we do lump sum investment for mutual funds or in the stock market?'. To learn the pros and cons of each strategy, there's an excellent research done by the Silicon Valley Blogger on thedigiratilife.

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