You might have heard of the term dollar cost averaging, or DCA. Let’s not change the terminology to Euro Cost Averaging here. Even for our European purposes, the principle works.
Quick Introduction to Dollar Cost Averaging
Simply put, DCA is a strategy slowly put your capital to work, for example in the stock market. The opposite of dollar cost averaging is a one-time lump-sum investment. Please know that when I use the example of the stock market here, you can also read “real estate” or “crowdlending”.
Basically, what you do is simple. You invest money on a very regular basis, for example, every month. No matter how high or how low the stock market is valued, you will put in the money. Usually, this will be the same amount of money every interval.
Now don’t take this literally. If you invest 950 EUR the first month, and 980 the next, you’re still dollar cost averaging. The main principle is that you don’t time the market by waiting to invest when the market is high, or investing more than usual when the market is low.
Two Types of Dollar Cost Averaging
There are two scenarios in which you might consider investing with the dollar cost average method.
The first is when you have deployed all your excess capital into the market already, and now you’re just investing the amount you save every month into the market.
The second scenario in which you might DCA your money into the stock market is when you suddenly receive a large sum of money, also called a lump sum. It might feel scary, especially at times like these when stocks and real estate are highly valued, to go all-in with this money. So instead, you use dollar cost averaging to slowly put this capital to work, spreading your investment.
Read more: How to Invest in ETFs with DeGiro.
Investing Your Monthly Savings
I you are investing a fixed monthly amount, you’re investing according to the DCA method. The idea is that you invest whether the market is high or low and because the dollar (or euro) amount is approximately the same, you will buy more stocks when the market is low and less when the market is high.
This ensures that you ride the waves, and you minimise the risk of investing right before the market drops.
When you are investing every month regardless of price, you will average out your purchase price. You can be making good purchases when stocks are cheap, without missing out on the “perfect buy”. DCA ensures that in a down market you keep investing and profiting from the cheap prices.
Investing a Lump Sum
Also when you find yourself having a lot of money to invest, dollar cost averaging is a popular investment strategy.
This can either happen when you have saved up a lot of money and then decide to invest this, or when you have gotten a lump sum out of an inheritance, insurance settlement, or anything else.
Investing this lump sum might be scary. Especially with the current high valuations, you might be afraid of putting a lot of money into the market right at the peak. That would hurt, right?
While that’s true, statistically speaking there’s nothing wrong with investing your lump sum. Since the market (historically) goes up two out of three years, in two thirds of cases you are better off investing your money all at once.
However, when you might lose sleep over the risk you’re taking, dollar cost averaging is the way to go.
An example would be to simply divide the amount of money you want to invest by 12, and invest this much every month. Then you’ve mitigated the risk of investing right at the top. However, if the market keeps going up, your average purchase price will be higher than if you’ve invested right when you got the money.
My Personal Preference
Because I have no leftover money, I always invest right when my salary enters my bank account. That means that from my regular income I’m definitely using the dollar cost averaging strategy.
When I’m receiving a one-time payment, depending on the amount, I will probably invest this immediately, not using the DCA method.
An example is the 2k EUR tax return I’m receiving this month. I will immediately put that money to work according to my standard investment allocation. However, if I were to receive more than that, I don’t know what I’d do.
Are you using the dollar cost averaging strategy? Why or why not?