Dollar Cost Averaging is the Best Way to Invest - The Broke Professional

Dollar Cost Averaging is the Best Way to Invest

Ask the average American or young professional what things SHOULD be doing with their finances.  You’ll get the usual answers like budgeting and saving.  They will also talk about how they need to spend less on things like eating out and clothes.

One other thing you’ll almost always hear about is the desire to invest.  Most people know they need to invest for things like retirement or a future house down payment.

The problem isn’t that we aren’t interested in investing.  Or that we don’t want to invest.

The main problem is that people don’t know HOW to invest their money.  They want to know which types of accounts to open and how to transfer money to keep investments growing.

This post will outline what I think is the most efficient and effective way to invest: Dollar Cost Averaging.

Dollar Cost Averaging: Slow and Steady Wins

There are essentially three ways to invest your hard earned money:

1.  Invest a lump sum all at once:  Mathematically, this is the most efficient way to invest.  Having a large amount of money invested in things like stocks or mutual funds will give your investment growth a turbo boost.

And studies have shown this.  Lump sum investing will give you the highest return over any other method of deploying your money.    And I would agree if you have a large sum of money, put it to work all at once if you intend to invest it.  No need having cash on the sidelines not working for you.

While this is the best way to invest, it’s only applicable a few times in life.  If you get a large sum from an inheritance, selling a business or a large bonus, then you should employ this strategy.

But most people get paid their salary in small intervals throughout the year.  So lump sum investing is not really in the discussion.

2.  Dollar Cost Average (DCA):  We live in a monthly payment kind of world.  Almost all of our bills including mortgage, auto loans and cell phones are debited once a month.  We’re used to being dinged monthly for the services we use.  Why not use that same mindset when it comes to investing our money?

This is why I love DCA and why it is my own preferred investing strategy.  Instead of investing haphazardly or when we hear a hot stock tip from a co-worker, DCA takes the emotion out of investing and lets you stick to your investing plan for the long term.

How does it work?  Let’s use a Roth IRA for example.  You know you need to save a little more for retirement beyond your company 401k, so you would like to set up a Roth IRA to be invested in the stock market.

Once you set up the account and select your investments (my favorite is VTSAX but that’s a story for another post), you will be asked to link your checking account.  Then you select how much you want taken out monthly and set your withdrawal date.  And that’s all there is to it!

You will be dinged monthly just like you would for any other bill.  But this is a good ding since that money will be invested for you retirement instead of being spent on the latest iPhone insurance.

3.  Don’t invest at all:  This is not recommended.  But it seems like it’s the American way since 1 in 3 Americans have no money at all saved for retirement.

Buy Low and Sell High

The best way to make money selling things is buying at a low price and selling at a high price.  That’s the logic behind dumpster diving and being a garage sale vulture.  And that’s also the logic behind making money as an investor.

Being invested in the stock market can literally be a roller coaster ride.  There are going to be ups and downs.  Sometimes really big ups and downs.  But as long as the price of your investments is more than what you paid for it initially, you will make more money.

Buying your investments at a low price and selling at a higher price is what makes investors money.  Many people get spooked and sell their investments when the stock market takes a sharp dive, like it did in 2008.  As a result, they lose a lot of money by buying high and selling low.  This is bad.

The beauty of investing via DCA is that it FORCES you to buy low.  If you decide to invest $100 a month into a mutual fund that costs $10 a share, that $100 investment will get you 10 shares.  If the mutual fund doubles to $20 a share next month, you will end up with only 5 shares.

While that is still more expensive than last month’s investment, DCA allows you to scoop up more investments while the shares are cheap.  Most people will actually do the opposite.  They will put a large amount of money into a “hot” stock or mutual fund while it is expensive.  This is not the way to invest.

DCA keeps the emotion out of investing.  By investing in regular intervals, you will keep your accounts growing while ensuring you are not buying too many shares at inflated prices.  This will set you up for nice investment gains when it comes time to sell.

Conclusion

DCA is the preferred way to invest for young professionals.  Early in your career, you will probably not have a lump sum to invest immediately in the stock market.  So investing as you get your paycheck is the most efficient way to deploy your capital.

DCA can come in many forms.  It can be an automatic deduction from your paycheck into your 401k account every 2 weeks.  Or a monthly withdrawal from your checking account into an IRA.

No matter what form it takes, DCA will keep your investment accounts growing steadily and will allow you to get the most shares at the lowest price.  No need for market timing since it doesn’t work anyway!

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Comments

  1. Solid advice! DCA ensures a consistent approach is deployed. And once that happens, a habit is created that we don’t need to think about. We can align our budgets accordingly knowing that DCA is forcing us to pay
    ourselves for our inevitable future first. And finally, don’t mess around with your contributions, unless of course you plan to increase them 🙂

    • Yup an increase in contributions is always a good thing! Momentum is a very real thing when it comes to growing your investments and keeping contributions going at a constant rate will keep increasing that momentum.

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