Dollar-cost averaging has its benefits as a way to minimize the risk of market fluctuations. This investment strategy requires investing the same amount regularly, (usually monthly) regardless of the price to lower its average cost per share and reduce the risk of buying at the most inopportune time.
Here are some of the mistakes investors should avoid in order for dollar-cost averaging not to get sabotaged.
Failing to recognize the benefits at an early age
Seeding the market with small sums regularly is ideal for younger investors who often have just an extra little income for investing. Also, the method teaches discipline, a valuable trait for investors to learn at a young age. It also teaches them to stay the course, particularly during bear markets, which offer the chance to buy shares at an affordable price. Over time, the benefits of systematic investing become evident as the account continues to grow.
Not investing consistently
Whether you invest a set dollar amount or a percentage of your income on a regular basis, do it the same way each time. Otherwise, you will end up saving at different ratios, which defeats the purpose of dollar-cost averaging, that of helping to smooth out the effects from the market’s peaks and valleys.
Forgetting to re-balance
This is the most common mistake dollar-cost-averaging investors make. For example, A portfolio invested in 60 percent stocks and 40 percent bonds will be out of balance after a year. Consequently, an investor will end up with a much more stock-heavy portfolio and a riskier allocation than was intended. Re-balancing a portfolio back to its original targets at least once a year is important.
Abandoning the strategy at the worst possible time
A turbulent market can scare off an investor and possibly make it think of taking a break from dollar-cost averaging. However, if you abandon the practice, your investing methodology becomes more about trying to time the market and chase returns, the two things financial advisors tell their clients not to do.
Being too hands off
Sticking to a plan isn’t the same as being disengaged. Sometimes a dollar-cost averaging strategy needs an emergency brake. A stop-loss order for selling an investment is set up in advance and triggered when the price drops by a predetermined account. Stop-loss orders are unnecessary if you’re dollar-cost averaging into a dividend-producing fund or an exchange-traded fund that invests broadly in the market.
Taking too long to invest a lump sum
Ironically, investors may want to use dollar-cost averaging more when it least benefits them. A study found that a lump sum invested all at once produced higher returns about two-thirds of the time than if the money had been invested in 12 monthly installments. Nevertheless, don’t take more than a year to invest all the money. Otherwise, you miss out on the gains from putting those dollars to work.
Ignoring trading costs and transaction fees
Because dollar-cost averaging requires buying into the market regularly, trading costs will add up if you’re not paying attention and can vary drastically by the brokerage. Costs typically are the least for stocks and exchange-traded funds. Keep in mind that a lower trading fund fee may have larger expense ratios.
See Also: Mistakes To Avoid When Investing in IPOs
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