How to Invest With Dollar Cost Averaging (Complete Guide)

Ruby Layram 12th Jul 2024 No Comments

Reading Time: 5 minutes

Investing can sometimes feel like navigating a maze in the dark, especially for beginners. But fear not! There’s a straightforward strategy that can make your investment journey a little simpler – dollar cost averaging.

Dollar-cost averaging is a popular investing strategy that makes it possible to build a diverse portfolio with a small amount of cash. In this guide, we will dive into what dollar cost averaging is, how it works and which type of investors it is best for.

A Simple Explanation of Dollar Cost Averaging
How Does Dollar Cost Averaging Work?
What Are The Benefits of Dollar Cost Averaging?
How to Invest with Dollar Cost Averaging
What Type of Investor is Dollar Cost Averaging Best For?

A Simple Explanation of Dollar Cost Averaging

First things first, what exactly is dollar cost averaging?

In the simplest terms, dollar cost averaging is an investment strategy where you invest a fixed amount of money at regular intervals, no matter the price of the asset.

This means you buy more shares when prices are low and less shares when prices are high. This can average out the cost of your investments over time.

Let’s use chocolate as an example. Instead of buying a year’s worth of chocolate all at once (and risking that you might buy it when prices are really high), you decide to buy a small, regular amount each week.

Some weeks, chocolate might be on sale, and you get more for your money. Other weeks, it might be more expensive, and you get less. But overall, you end up paying a fair average price for your year’s supply. That’s the basics of dollar cost averaging!

How Does Dollar Cost Averaging Work?

Dollar cost averaging works by taking advantage of price fluctuations.

Instead of trying to time the market – which is easier said than done—you invest the same amount regularly, no matter what.

This consistent investment approach helps you avoid emotional decision-making and the headache that comes with market timing.

The process of dollar cost averaging is pretty simple. You decide on a fixed amount of money to invest at regular intervals (weekly or monthly). Then, you choose a selection of shares to put the money into each time.

The idea is that you stick to your plan no matter what. The easiest way to do this is through automation.

By following this strategy, you make sure that you are consistently building your portfolio and taking advantage of different market conditions. This reduces the risk of making poor investment decisions based on market highs or lows.

Dollar Cost Averaging Example

Suppose you decide to invest £100 every month into a stock. In January, the stock price is £10, so you buy 10 shares. In February, the price drops to £5, so you buy 20 shares. In March, the price rises to £20, so you buy 5 shares.

Over three months, you’ve invested £300 and purchased 35 shares. The average cost per share is approximately £8.57, even though the price fluctuated between £5 and £20. By spreading out your investments, you’ve managed to buy more shares when prices were low and fewer when prices were high, leading to a lower average cost per share.

Investing this way takes away the stress of timing the market perfectly. Because let’s face it, no one knows exactly what the market will do!

What Are The Benefits of Dollar Cost Averaging?

By now, you should have a pretty clear idea about what Dollar Cost Averaging is. But, why might someone choose to do it?

Suitable for Small Budgets

One of the best things about do9llar cost averaging is that it doesn’t require a large upfront investment. You can start with whatever amount fits your budget, making it accessible for everyone. Whether you have £50 or £500 to spare each month, you can start investing right away without waiting to save a large sum.

You might also like: How to build an investment portfolio with £1

Reduces Emotional Decision Making

Investing can be an emotional rollercoaster. It’s easy to see ultra-low prices and buy out of FOMO or to avoid buying altogether if prices seem a bit steep. Dolla cost averaging helps take the emotion out of investing by sticking to a predetermined plan. You invest the same amount regularly, which means you’re less likely to make impulsive decisions based on market fluctuations.

It’s Simple!

Simplicity is a significant advantage of this investing strategy. There’s no need to constantly monitor the market or stress over the perfect time to buy. You set your investment amount and schedule, and then you stick to it. This straightforward approach makes investing less daunting and more manageable, especially for beginners.

How to Invest with Dollar Cost Averaging

If dollar cost averaging sounds like the best strategy for you, here is a step-by-step guide to how to get started.

Determine the amount you would like to invest: Decide on an amount you can comfortably invest regularly without straining your finances. 5% of your monthly income is a good starting point.
Choose an investment: Choose what you want to invest in, whether it’s stocks, mutual funds, or ETFs. You should do a bit of research here to find something that aligns with your long-term goals and strategy. Also, try to aim for diversification by spreading your investments across a basket of assets (ETFs are great for this!).
Set up automatic investments: Most brokerage accounts allow you to set up automatic investments. This way, your chosen amount is invested at regular intervals without you having to lift a finger.
Stick to your plan: Consistency is key! Stick to your investment plan regardless of market conditions. Remember, the goal is to average out the cost over time.

Dollar cost averaging is an excellent investing strategy for both beginners and experienced investors who want to build a diverse portfolio. The best part is that you can start with as little as £1 (with some brokers) which means that you do not need to put huge amounts of money on the line to try it out.

Remember, all investing comes with some risk and it is important to make sure that you only invest with money that you can afford to lose. Do not automate investments if it will leave you feeling financially strained!

Are you interested in learning more about investing? Why not sign up to the MoneyMagpie bi-weekly Investing Newsletter? It’s free and you can unsubscribe at any time if you find it isn’t for you.

investing newsletter

Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. When investing your capital is at risk.