The fear that you’ll make a mistake like investing just before a stock market crash can make investing scary. That dread may be so great that it keeps you from doing anything at all.
Dollar-cost averaging is a strategy where you invest a pre-determined sum periodically throughout the year, usually monthly, and it can help alleviate this concern. With this process, you build your portfolio over time. Some months you’ll get lower prices, and some months you’ll get higher prices, but most importantly, you’ll actively participate in the stock market and master it in these three ways.
1. Time in the market
When the stock market plummeted in March due to COVID-19 concerns, you may have thought the downfall would last a long time and be more severe than it actually was. But the recovery was quick, and now new market highs have been reached. If you are someone who was waiting for an even deeper decline before investing money this year, you may still be sitting on cash.
The S&P 500 started off the year trading at 3,231, plunged to 2,237 on March 23, and is now trading at 3,703. If you exactly timed this bottom, you would’ve seen about a 65% increase in your accounts year to date. Timing this perfectly would’ve been very difficult, though. The markets did rebound, but they could’ve gone down further, and your outcome would’ve been drastically different.
Dollar-cost averaging lets you say goodbye to this guessing game and buy in at different prices throughout the year. If instead of trying to time the bottom, you’d decided that you would put $1,000 in an S&P 500 fund like the SPDR S&P 500 ETF Trust (NYSEMKT:SPY) on the first trading day of every month, you would’ve gotten different prices throughout the year. Your purchase prices would’ve decreased monthly through April 1, but starting in May, you would’ve seen them mostly increase each month. Using this strategy, your return wouldn’t be as high as if you’d been lucky and gotten in at the bottom. But it would be significantly better than if you’d done nothing at all and were still holding cash.
2. Better management of your emotions
The stock market is cyclical, so there will be bull markets, bear markets, and flat markets. If you are afraid that you will lose your nest egg if you put a lump sum of money into the market at the beginning of a bear market, dollar-cost averaging can help take away your apprehensions.
Imagine you invested $12,000 into the SPDR S&P 500 ETF at the beginning of the year. When the markets plummeted in March and the fund shrank by more than 30%, your $12,000 would’ve decreased to less than $8,400. Fearful of losing more, you might have even sold out of your…
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