A fluctuating market can make investing appear daunting. When markets drop, gloomy headlines might discourage prospective investors, leading many to stay on the sideline. However, market pullbacks often present a valuable opportunity to invest. A systematic method such as dollar-cost averaging enables investors to capitalize on the market fluctuations that immobilize many into inaction.
How does Dollar Cost Averaging (DAC) Work?
At its core, dollar-cost averaging is straightforward: consistently invest a set sum at regular intervals, irrespective of market ups and downs. For the sake of simplicity, let's assume you are investing in a single fund. You buy more units when prices are low, and fewer units when prices are high.
This is demonstrated in the table below.
Investment Amount | Unit Price | Units Purchased* | Total Units |
$1,000 | $20 | 50.00 | 50.00 |
$1,000 | $17 | 58.82 | 108.82 |
$1,000 | $19 | 52.63 | 161.46 |
$1,000 | $22 | 45.45 | 206.91 |
Average unit purchase price: 19.33
* Fractional units are only available for mutual fund purchases. ETFs can be purchased solely in whole unit increments.
The Benefits of Dollar Cost Averaging
The benefits of dollar-cost averaging include:
Disciplined investment approach
Dollar-cost averaging promotes consistency as it requires investing a set amount either monthly or quarterly, regardless of market fluctuations. This strategy discourages hesitating to invest during uncertain or volatile times. Indeed, dollar-cost averaging is most effective in fluctuating markets.
Avoids market timing
Attempting to time the market, by selling at its peak and buying at its lowest, is challenging to achieve consistently. In contrast, dollar-cost averaging ensures investments are made routinely, either monthly or quarterly.
Potentially lower the average cost
When you invest a consistent amount, you purchase more units during price dips and fewer during price hikes. This leads to an average cost that's typically lower than the market's average price, provided the market fluctuates both ways.
The Drawbacks of Dollar Cost Averaging
In certain market conditions, a lump-sum investment might yield a higher return than dollar-cost averaging. Particularly in steadily rising markets, making multiple smaller investments at different times could lead to missed gains. However, given the unpredictability of future market fluctuations, dollar-cost averaging remains a wise investment tactic.
How Do I Set Up Dollar Cost Averaging at ModernAdvisor?
To establish dollar-cost averaging with ModernAdvisor, we advise creating two accounts:
Account A: A short-term account invested in the ModernAdvisor High Interest Savings Portfolio.
Account B: A long-term investment account tailored to your risk tolerance, timeframe, and objectives.
Once these accounts are in place, you can deposit your funds into Account A. The money in Account A will then be allocated to a High Interest Savings fund that pays monthly interest.
For a gradual market investment approach, initiate a recurring internal transfer on your dashboard, such as on a monthly basis, from Account A to Account B.
The subsequent steps are automated and overseen by ModernAdvisor. According to your preset schedule, we liquidate a designated amount of funds from Account A, transfer the proceeds to Account B, and then invest in funds within Account B that align with your long-term investment strategy.