How to always make money in the stock market? What is a Dollar Cost Averaging?

Today, I will introduce you to a very useful concept called Dollar-cost averaging. It is an investment strategy where you invest a fixed amount of money every period, such as every month, despite the stock market trend. You could invest your money in an index or mutual fund, or electronically traded funds (ETF).

So, no matter how the stock market behaves if you keep putting in a fixed dollar amount every period, over the long run, it will surely give you good returns.

Let’s understand this with a help of an example. The dollar amount you contribute each period, divided by the stock price, gives you the number of stocks you buy for that period. So, when you invest a fixed dollar amount (let’s assume you contribute every month), you end up buying fewer stocks when the stock price is high.

Conversely, when the stock price falls, you buy more stocks for the same dollar amount you invested during that month. This way, your average purchase price per stock stays low over time.

There is an excellent example explaining dollar cost averaging that I found on the Charles Schwab website.

To be a successful investor, you need to have patience and invest for the long term. People expect their money to grow overnight and this certainly doesn’t happen.

Why people need to use this strategy?

People try to buy stocks when their prices are falling and sell when they are rising to make profits. But it is very difficult to time the market. There is no foolproof way to know how the stock price will behave the very next day or coming days.

Sometimes, you may buy a stock thinking it is selling at a low price and will rise in the future. If the stock price rises and continues to rise, you made a good investment decision until you sell it at a higher price and make a profit. However, if the stock price falls further for the next few days, and you end up selling it at a lower price than you bought it for, you made a mistake.

In reality, people panic and start selling individual stocks when the stock prices are going down. This is actually the wrong thing to do.

Also, people, sometimes, don’t buy those underpriced stocks thinking they are not performing well and will continue to fall.

We, as individual investors don’t have enough information about a specific company and other economic events. Hence, our guesses about market stock price and index movements are not always correct.

How does Dollar cost averaging help?

This can be avoided when we invest a fixed dollar amount. With dollar cost averaging, you can stick with a good investment schedule and will not overthink about when to buy or sell stocks.

Thus, a big advantage of dollar-cost averaging is that it is a worry-free method of investing. The emotions and anxiety associated with investing are taken out and you just invest a fixed amount at a fixed time (such as every month), ignoring the market ups or downs.

An example of dollar-cost averaging investing would be the investments done through your employer’s 401k plan. Here you and your employer contribute a fixed amount of money towards your retirement income.

I hope you learned something from my post today. If you haven’t already, you will start making use of this useful technique in making your investment decisions. Also, please start early, as time is the key. After creating the emergency fund in your savings account, invest your money so it can grow.

Disclaimer: The information presented here is for educational purposes only. I am not a financial advisor and do not provide investment advice. I recommend you consult a qualified financial advisor to make investment decisions.