Part 1: What is Dollar Cost Averaging
Part 2: Dollar Cost Averaging: Pros and Cons
Introduction to Dollar Cost Averaging for Kids, Teens and Beginners
This video explains the concept of Dollar Cost Averaging or Constant Dollar Plan in a simple, concise way for kids and beginners. It could be used by kids & teens to learn about Dollar Cost Averaging, or used as a money & personal finance resource by parents and teachers as part of a Financial Literacy course or K-12 curriculum.
Suitable for students from grade levels:
- Elementary School
- Middle School
- High School
The topics covered are:
- What is Dollar Cost Averaging or Constant Dollar Plan
- How does this investment strategy work, and always make money in the stock market
- Detailed example
- Its advantages / pros
- Its disadvantages / cons
- How to implement this investment strategy
Part 1: What is Dollar Cost Averaging
An investment strategy that always makes money
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.
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Why does this strategy always work?
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?
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…
Part 2: Advantages and Disadvantages / Pros and Cons
You explained how I can always make money using Dollar Cost Averaging.
Does it have any other advantages?
Apart from providing consistent returns, the biggest advantage of Dollar Cost Averaging is to remove the emotion and anxiety from investing – you invest a fixed sum at a fixed time, without worrying about whether the market is going up or down.
Normally, when a stock’s price is going down, people avoid buying the stock thinking it is not performing well. But with Dollar Cost Averaging, you would continue to buy the stock even while its price is going down – and why not? You’re getting the stock at a discount!
Wouldn’t you be happy buying your favorite pair of shoes at a discount?
Are there any disadvantages of Dollar Cost Averaging?
A perfectly executed strategy of buying at the lowest price and selling at the highest price can theoretically give a better return – something Dollar Cost Averaging can’t.
However, this is not a real disadvantage because it’s impossible to time the market consistently.
How can I implement the strategy of Dollar Cost Averaging?
Do I need to remember to invest the amount every month? That’s sounds hard!
No, most brokerages can help you automate this process – you just need to tell them how much money to invest, where, and how often, and they would take care of investing the money on your behalf.
And if you are investing through a 401k plan, then you are already taking advantage of this strategy!
Note: Dollar Cost Averaging is also known as Constant Dollar Plan.