Is there an investing strategy using which you can always make money?
People usually try to time the market, which means they want to buy when the stock market is at the bottom, and sell when it’s at the top. However, this doesn’t work most of the time, since consistently predicting market tops and bottoms is not possible. The only strategy that has proven to give consistently good returns is Dollar Cost Averaging.
What is Dollar Cost Averaging?
It is an investment strategy where you invest a fixed dollar amount in a stock, mutual fund or ETF periodically – usually every month – irrespective of the stock price, and without worrying about market tops and bottoms.
Why does this always work?
You know that stock market is very volatile, which means that the prices can change drastically in the short term. However, we also know that the stock market always goes up in the long term.
When you invest a fixed amount periodically, you buy less stocks when the stock price is high, but when the stock price goes down, you buy more stocks for the same amount. That way, your average purchase price per stock stays low over time. That is why this strategy gives great returns in the long term.
Can you give me an example?
Let’s say you invest $100 in an S&P 500 based index fund every month for 12 months. The price fluctuates throughout the year, but as you can see in the chart, even when the price at the beginning and end of the year is the same, your average cost price per stock is lower, and you can make a profit if you sell. Whereas if you had made your entire purchase at the beginning, you would have not made any gain at the end of the year.
Are there any other advantages of Dollar Cost Averaging?
Sure there are. But that’s a topic for another time…