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Dollar Cost Averaging: Should You Buy Stocks Over Time To Save Money?

23 January 2014 No Comment

canstockphoto0751225You’ve heard of dollar-cost averaging before, but you’re not sure it’s the right thing to do. Right now, you just buy investments as you see fit and when you can afford to invest money. But, your broker is putting a bug in your ear to save money over the long-term by making regular purchases. Should you?

The Pros:

  • It’s Affordable – This is a big one. Most people find that dollar-cost averaging is an affordable way to invest in stocks. With dollar-cost averaging, you choose three parameters. First, you decide how much money you want to invest. Then, you decide the frequency you want to invest. Finally, you decide for how long you want to invest. So, for example, you might choose to invest $500 (the amount) every month (the frequency) for 12 months (the time horizon).

    This makes it easy to make a budget and stick to it. You just add the dollar amount to whatever you’re spending right now and it’s sort of like investing on autopilot.

  • It’s Convenient – There’s not a heck of a lot to think about once you’ve decided on the three parameters. You just keep investing every investment period until you’ve invested all of the money you previously decided to invest.

The Cons:

  • Lump Sum Investing Might Improve Your Returns – One major drawback with dollar-cost averaging is that you’re not taking advantage of cheap stocks when they’re cheap. In fact, the whole idea is that you pay an average price for the stock over time. This is supposed to optimize what you pay so you don’t have to guess at what the cheapest price is.

    But, this tries to shortcut an important premise in value investing. Namely, that your job, as an investor, is to buy cheap stocks and then hold them until their intrinsic value has been achieved. If you’re dollar-cost averaging, you can’t do this. All you can do is get an average price. It muddles your returns.

    On the other hand, if you invested lump sum amounts, you would be able to realize the full profit on a good investment.

  • There’s More Fees – Because you’re making regular purchases over an extended period of time, you’re going to rack up more fees with your broker. That’s good for the broker, but not so good for you. You can use sites like BrokerStance to help you navigate the mine-field of online brokers so that you can hopefully avoid the ones that are out there to maximize their earnings off of you, but most brokers are of the opinion that dollar-cost averaging is “smart.” At the end of the day, all it really does is lower your total return. That doesn’t sound so      smart, does it?

What Should You Do?

You’re looking for a broker that has your best interests at heart. There’s a lot you can do to make sure you end up with someone you like and that’s good for you.

First, try to work with an online broker. These brokers offer the same service as traditional brokers, but they charge lower commissions. Find one that also offers additional assistance – some of them will do it at no additional charge.

Ask about the broker’s investment philosophies. This could clue you into how the broker will steer you in regards to investing strategy. While many brokers do recommend dollar-cost averaging, some don’t. Some brokers are focused more on helping you find long-term plays that will pay off in a big way.

These brokers are value investors and are more concerned about getting you into a stock at a good price instead of getting you into a stock over time.

Can Dollar-Cost Averaging Ever Be A Good Idea?

Believe it or not, there are times when dollar-cost averaging makes sense. Usually, it’s when you’re hunting for the bottom of the stock’s price but you don’t know where it is. If a stock starts to fall, in price, you want to buy it at the moment it rebounds and not a second too late. But, this can be an almost impossible task.

Dollar-cost averaging allows you to get close to an ideal price, especially if the stock is falling slowly and is expected to make a recovery soon. Keep in mind that this strategy works well when you expect a major recovery in a company’s stock price – you’re paying commissions on every trade you make. So, the recovery has to be enough to make the entire investment profitable.

Jarryd Harden has years of experience working in finance. He greatly enjoys blogging about his insights into smart investing and money management.

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