Dollar cost averaging (also known as DCA) is an investment strategy that may be used with any type of investment. It works by investing equal amounts regularly and periodically over specific time periods, like $100 very month, in a particular investment or portfolio. By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high. The point of this is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time. However, to get the best purchase price it is beneficial for an investor to not only dollar cost average, but to also purchase additional shares in a stock, or mutual fund, when the shares are lower. This will result in the better investment returns. This scenario can be seen in the example below where the S&P500 is lower on March 9, 2009. This lower purchasing opportunity can be assessed by the green signals in the RSI below (bottom blue circle).
If an investor had added more money to the S&P 500 during this time, they would have bought shares at a very low price. This results in a much higher returns over the long term than simply dollar cost averaging would by itself. Using both methods of DCA and buying additional shares when the market is low, will result in much better return than DCA would by itself.
Long term investing is beneficial to investors because it can lead to positive gains in the stock market with very little risk. This happens because investing for the long term in the stock market in stocks such as those in the S&P 500 can result in an aver annual gain of 12% over the long term. This is based on the fact that the S&P 500 has returned an average annual return of 12 % since 1926. With this kind of return an investor can expect their investment to double every six years. This is concluded by using the rule of 72; divide any return into 72 and you get the number of years it take to double an investment. Hence, 72 divided by 12 equals: 6. Therefore, it’s easy to see that long term investing is something that every investor should do. This can be done easily with dollar cost averaging.