Many experts have spoken on the benefits of dollar cost averaging, also known as DCA. But what is it, and can you do it with your exchange traded funds (ETFs)?
Carlos Sera of Financial Tales defines dollar cost averaging as when one commits to invest a certain dollar amount or percentage of salary to an investment program, usually in a mutual fund or exchange traded fund (ETF), over a consistent period of time. A good example is a traditional 401(k) plan to which an employee allocates 5% of a monthly paycheck. Sera has several tables illustrating how DCA works. (More on retirement).
Sera likes the dollar cost averaging method because it can encourage someone to invest in the stock market, which in turn gets them on their way to higher lifetime rates of return and a higher standard of living. Another benefit is that when stocks are cheap, you’ll wind up buying more of them; when they’re expensive, you’ll buy less.
As far as whether or not it works, it enables and encourages many individuals to start saving and building retirement plans. It also positions them to take advantage of bargains in the market. Over time, Sera says, if an investor sticks with it, DCA could produce satisfactory results.
Our own strategy is one of trend following by using the 200-day moving average to determine when you’re in the markets and when you’re out. (How to use the trend following strategy).
Whichever strategy you employ when investing, pick one and stick with it. Bouncing around from one method to the next could wind up being costly to you, and can lead to frustration as you look for a strategy that “works” before giving any of them a chance to do so. Success doesn’t happen overnight!
For more stories on trend following, visit our trend following category.
Kevin Grewal contributed to this article.