Dollar-Cost Averaging May Help Investors Hedge Against Market Volatility
What is Dollar-Cost Averaging?
It could be a volatile fall for the stock market. Investors are keeping an eye on US-China tensions, the presidential election in November, COVID-19 cases, and other factors that could impact indexes for better or for worse.
People who are reluctant to take on extra risk right now but are looking for ways to maintain exposure to certain securities might want to consider an investment strategy called dollar-cost averaging.
Dollar-cost averaging just means regularly putting a set amount of money into an investment. A 401(k) retirement account is a form of dollar-cost averaging, because money regularly comes out of a person’s paycheck and is invested. There are also a number of other ways to invest with dollar-cost averaging such as picking a stock, bond, fund, or any other asset and contributing set amounts on a consistent basis.
Advantages of Dollar-Cost Averaging
Dollar-cost averaging is helpful during times of market volatility. If a person consistently puts money into the stock market, they will sometimes buy at times when the market is low, and will sometimes buy when the market is high.
This is a safer strategy than “timing the market.” Sometimes, investors will pile into a stock as it is going up, hoping it will continue to rally. This can be a good strategy if the stock keeps rising, but it is also very risky. Stocks are unpredictable, and can sometimes tumble as quickly as they rise. Dollar-cost averaging allows people to buy stocks consistently over time, which smooths out the average buying cost.
Additionally, when stocks fall sharply, investors often stop buying them for fear they will continue to drop. By creating a plan to regularly buy stocks, investors can sometimes take advantage of low prices when others are afraid to buy.
What to Consider When Setting Up Dollar-Cost Averaging Strategy
Dollar-cost averaging is a relatively hassle-free way to invest. It takes a bit of research up front to set up a dollar-cost averaging plan, but after that, this type of strategy usually works best when investors stay consistent and disciplined.
To get started with dollar-cost averaging, an investor needs to choose if they want to put money into stocks, an exchange-traded fund, or a mutual fund. An individual stock will likely fluctuate much more than a fund will. The next step is for a person to look at their budget and figure out how much money it makes sense for them to invest through dollar-cost averaging over a set amount of time. Most financial advisors recommend leaving this type of investment for at least three to five years.
The one drawback of dollar cost averaging is that more buying can lead to more trading fees on certain platforms. However, there are no trading fees when you buy and sell stocks with SoFi Invest®. Plus, you can invest with ease—no matter what your experience level.
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