“Time in the market beats timing the market.” - Ken Fisher
Not even the most seasoned experts can predict stock movements. As a result, there is always a risk of buying too soon and seeing a stock price fall, or not buying soon enough and missing out on the best returns. Dollar-cost averaging is a strategy that lets you balance out potential volatility and which has been historically proven to be effective.
In this article you’ll learn about the following topics:
• What is dollar-cost averaging?
• What are the advantages of dollar-cost averaging?
• What are the disadvantages of dollar-cost averaging?
• An example of dollar-cost averaging
• Who should use dollar-cost averaging
What is dollar-cost averaging?
If we could all buy stocks or other investments when the market is down and sell them when it is strong, investing would be easy. Unfortunately, attempts to "time the market" are more often than not unsuccessful, as investors can often make erroneous purchases and sales in doing so.
Dollar-cost averaging involves gradually purchasing stocks over time by investing the same amount at regular intervals, such as every month, regardless of market fluctuations.
Individual investors often sell shares when equities fall due to fear of losses; conversely, they often jump back in when the stock market is booming, for fear of missing out. Over time, this erodes portfolio returns, as individual investors are often buying high and selling low driven by euphoria and panic, respectively.
Dollar-cost averaging assists in freeing the investment process from subjective opinions and emotions and feeling the need to time the market.
When investing using dollar-cost averaging, you purchase more security shares when the price is low and fewer shares when the price is high. Over time, this process results in you paying a lower average price per share overall.
Dollar-cost averaging may be effective for Bitcoin investors, too. It was recently reported that two of the world's largest crypto investors are dollar-cost averaging into Bitcoin. President Nayib Bukele of El Salvador and renowned crypto tycoon Justin Sun purchase one Bitcoin every day, regardless of the state of the market.
What are the advantages of dollar-cost averaging?
As markets fall, by employing the dollar-cost averaging approach, you will buy assets at a lower cost ready for future gains, as markets rise that will raise your portfolio's worth over time.
It's challenging to predict fluctuations, given the many factors that can affect a stock’s price, many of which can’t be predicted at all. The dollar-cost averaging method balances out the cost of purchases, irrespective of stock and market fluctuations, which is to the investor's advantage over the medium to long term.
Dollar-cost averaging also encourages Investors to concentrate their efforts on the long term and ignore the noise and hype of daily reports about the stock market's short-term performance.
What are the disadvantages of dollar-cost averaging?
Dollar-cost averaging also has flaws, like any other investment technique.
The market's propensity to rise over time is a drawback of dollar-cost averaging, as this suggests that investing a substantial sum upfront is likely to perform better than investing smaller sums gradually, depending on the timing of the upfront lump sum investment of course.
Another disadvantage of dollar-cost averaging is that it can mean higher fees, as you’re buying smaller amounts of assets more often.
Dollar-cost averaging also prevents you from realizing larger returns if you enter and leave markets with larger investments at favorable moments, whether by investment skill or by luck. However, few investors can point to a consistently good track record in this respect, so you also risk bigger losses.
An example of dollar-cost averaging
Jim has $600 to invest, and he decides to invest it as $100 a month for six months to purchase shares in a particular index-tracking mutual fund each month. The equities are traded for $10 per share throughout the first month, so Jim purchases a total of 10 shares in the first month. In the following 2 months, the share price falls to $5, and Jim can buy 20 shares each month, so he has 50 shares after 3 months.
In the fourth month, the share price reverts to $10, and in the fifth and sixth month it rises to $20. At the end of six months therefore, Jim has 70 shares, and a total portfolio value of $1,400 on a $600 investment, despite the fluctuations in the fund price. This is thanks to the fact that he was able to buy more shares when the price dropped, making more profit when it rose again.
On the other hand, If he had bought $600 of stocks at the start, he would have $1,200 total value.
This demonstrates the advantage of dollar-cost averaging long term.
If he had waited until the price dropped and spent the whole $600 the second month, he would have had a much higher return of $2,400, however that would have relied on timing the market, which it is very rare to get right.
Who should use dollar-cost averaging?
Expat investors can use dollar-cost averaging to buy stocks, or mutual or index funds, or other assets such as bonds.
It is a strategy that allows you to avoid the stress and hassle of worrying about market timing and volatility,allowing an investor to accumulate wealth over different points in the economic cycle and build a robust portfolio over time.
If your investment goals have a shorter time horizon however, it may not be the best strategy, and it’s also possible that you can miss out on significant gains compared to buying more when prices are temporarily depressed.
If you are a risk-averse investor, or worry about market volatility, and you have a long-term approach to investing, using dollar-cost averaging as an investment strategy is definitely worth considering.
Wrapping up
#Don’t forget that expats investing abroad can incur additional US tax and reporting requirements, and particularly relating to non-US mutual funds.
When considering dollar-cost averaging or other investment strategies, always discuss your ideas and plans with your expat financial advisor, who will be able to guide you through the risks, benefits and implications so that you can make a truly informed decision.
If you have any questions, don't hesitate to contact us.
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