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All About the Dollar (Cost Averaging)

Dollar cost averaging is a simple, yet effective investment strategy. In effect, you as an investor contribute a set amount of money to an account to buy a fixed amount of an investment regardless of share price. For example, you can set aside $100 a month to invest into a particular product, thereby averaging out the cost per transaction given the fixed amount contributed over the lifetime of your investment. Using dollar cost averaging will allow for you to begin to accumulate wealth in the stock market just as setting aside a pre-determined amount each month for savings will create a financial safety cushion.




Additionally, dollar cost averaging is an excellent way to eliminate trying to time the market, which in most cases can lead to paralysis by analysis. In other words, creating a systematic process for investing can help automate the saving process and focus your thoughts on long-term results.

For those of you who are new to investing, dollar cost averaging is an excellent method for getting started. During the early stages of your financial education doing anything can feel quite daunting and overwhelming with all the information available. However, the best thing to do when you are starting out is to actually begin investing. That is, start putting money to work for you. The sooner you can invest the better since the money will have more time to grow and compound*, thereby becoming more valuable in the future. In finance, this concept relates to the Time Value of Money. Simply put, money invested today is more valuable than the same amount in the future due to its greater potential earnings ability.

In some ways, dollar cost averaging can function much like a 401K** plan where the investor contributes a set amount of money on a regular basis. However, you have the flexibility to dollar cost average money into either a tax-deferred (e.g. Traditional or Roth IRA) or a taxable account (e.g. a brokerage account). For example, the maximum contribution for a Traditional IRA or Roth IRA is $5500. This amount can either be deposited into your IRA as one lump sum or through a series of smaller, equal contributions on a routine basis. If you opt for the latter, a set amount of money will be invested proportionately across your asset allocation. So long as the asset allocation remains intact, funds contributed during that time period will be dollar cost averaged into your 401K account.

Some good products for a dollar cost averaging strategy include Exchange Traded Funds (ETF’s)*** and individual stocks. However, investors should shy away from more volatile products like leveraged ETF’s and most small-capitalization companies. Instead, invest the money in an ETF that mirrors an index like the S&P 500 or purchase shares of a Blue-Chip**** company. These investments are simple, yet effective wealth building products.

While dollar cost averaging is a good way to invest, no method comes without some form of risk. For instance, if you dollar cost average into a stock that continues to decline for a sustained period, you should look at putting the money into another company or an ETF. When creating your plan to dollar cost average, be sure to have an entry and an exit strategy. In other words, think about the possible outcomes and how you will manage them in the future. Doing this sort of planning at the onset is much easier with a clearer mind than in the midst of reassessing during potential market turmoil. Instead, validate your returns to regularly check on your investment and grade its performance.

Hopefully this information illustrates how dollar cost averaging can help establish some savings and improve your overall financial picture.

As always, if you have questions or comments, feel free to send me a message. Thanks for reading.

JD

*See my post entitled “Daymond John’s Money Tips” here for an explanation of compounding.

**Refer to “The Benefits of Participating in your Company's 401K Program” here for an overview of 401K plans

***See “What You Should Know About ETF's” here for an overview of ETF’s

****Reference “Blue Chips: Not the Kind You Eat” to get an understanding of these stocks here



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