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Is investing a task perpetually on your "to-do" list? Are you befuddled by market timing, wondering when and how to invest your money?
You can invest effectively without being a market guru or knowing how to time the markets. (In fact, nobody can accurately predict the markets 100% of the time, no matter how good they are).
With dollar cost averaging, you take the guess work - and the grunt work - out of investing, safe in the knowledge that you are getting the best average returns for the least effort expended.
What is Dollar Cost Averaging?
Dollar cost averaging involves investing a set amount of money on a regular basis into a given investment. For example, let's say you have $100/month to invest. You set it up to be automatically withdrawn from your account and deposited to an investment of your choice.
Advantages of Dollar Cost Averaging
First off, dollar cost averaging is maintenance-free once it is set up. And because you can set the withdrawal dates and intervals as you please (for example, weekly, bi-weekly, semi-monthly, or monthly), you can arrange for the money to be withdrawn right after payday; this is the best way to "pay yourself first".
Additionally, dollar cost averaging carries the advantage of giving you the best passive returns on a fluctuating investment. Let's illustrate:
How it Works
You invest $100/month into Investment A; for example a mutual fund with a price that fluctuates with the underlying investments.
Month 1: Price = $10; $100 gets you 10 units
Total Investment Value: 10 units x $10 = $100
Month 2: Price = $20; you get 5 units
Total Investment Value: 15 units x $20 = $300
Month 3: Price = $5; you get 20 units
Total Investment Value: 35 units x $5 = $175
Month 4: Price = $10; you get 10 units
Total Investment Value: 45 units x $10 = $450
After four months, you have invested $400 of your own money, and despite the fact that the investment is the same value as it was when you started (which would be a 0% return if you had invested the entire $400 on day one without further investments), you have made $50, a 12.5% return!
This example uses a wildly fluctuating investment and is being used for illustration purposes only. Your investment preferences should be dependent on your time frame and tolerance of risk; something your financial planner can help you with.
You don't need to have $100 to start dollar cost averaging. Many investments allow you to get in with as little as $25.
Buy Low, Sell High
You might suggest your returns would be higher if you had invested the whole $400 when the price was $5. While this is true, statistically it's very difficult to predict when you're at the bottom, and most investors become scared when an investment plummets; buying at the right time is difficult.
By dollar cost averaging, you're lowering your average cost to buy an investment, thus increasing your returns over time, without you having to constantly monitor it.
All this gives you the peace of mind of knowing you're saving money, while allowing more time for the things you love to do.
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Nora Dunn is The Professional Hobo: a full-time traveler and freelance writer. She is a contributing writer under the CareOne Debt Relief Services Life Balance blog. Having sold her business and belongings to travel, she has been on the road since 2007. She travels in a financially sustainable manner, taking advantage of creative volunteering positions. As a former certified Financial Planner, she is financially responsible for her actions along the way. She believes there is a fine balance between planning for tomorrow, and living for today. Compensated Blogger for CareOne Debt Relief Services. You can follow Nora on Twitter @hobonora
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