Dollar-Cost Averaging: 8 Tips To Do It Effectively
Dollar-cost averaging is one of the most widely available strategies in investing. In simpler words, it is the adage of buying more when prices dip.
However, there have been misconceptions and theorists giving unreasonable examples on dollar-cost averaging. Though it seems easy to just say buy more on the dip, there are actually strategies that one should stick to.
Here are 8 tips to actually improve your dollar-cost averaging.
1. Begin with the end in mind
Investing is never about an individual hit or miss gameplay. It is ultimately a portfolio of stocks coming together to compound our wealth.
By doing dollar-cost averaging, we are increasing the size of a company holding inside our portfolio. Sometimes, averaging without knowing how big that company will contribute to our portfolio could be risky.
It is crucial to plan out how many stocks to own in your portfolio, and how much cash to hold as well. In the event, a company becomes too big of a contribution, you might need to think twice about adding more.
2. Know your risk appetite when dollar-cost averaging
Risk appetite is subjective to each and every one of us. For those who are risk aversive, it would be wise to have a well-rounded and diversified portfolio. That means you should not be blindly doing dollar-cost averaging at every dip.
Conversely, those who have a better risk appetite can surely do much more frequent dollar-cost averaging. But do note that it must also fall within the game plan and adhere to our end in mind. Having a concentrated portfolio is relatively higher in volatility and risk, but could translate into higher gains if the dip is temporary.
Hence, it is important to know what is your risk appetite is before mindlessly going onto a dollar-cost averaging spree.
3. Invest for a long time horizon
Dollar-cost averaging, especially averaging down, is a fundamental approach to buying a great company at a steeper discount. However, even the best investors would not know the actual time when a share price will rebound.
Hence, dollar cost averaging is best when paired with a long term horizon investment approach. By giving a company time to grow and get past short term headwinds, investors will be well-positioned to ride on any potential upsides.
Impatient investors, however, would see their losses deepen and eventually end up with bigger realized losses if they do not have a long term horizon.
4. Ensure you are not buying a value trap
One risk that even the best investors could fall into is buying into a value trap. Value traps are essentially stocks that are trading at a relatively cheaper valuation.
Value traps are not always straightforward. Sometimes, they do take time to manifest themselves. And with a stock trading cheap, even though with good fundamentals, investors could eventually end up buying into a value trap.
There are plenty of ways to detect value traps. Here are a few examples and tips that we share.
By ensuring that a stock is not a value trap, investors can be more confident in dollar-cost averaging.
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