Except for July and August in Arizona, when it comes to getting into the pool, I am a toe-dipper; an incrementalizer; a proceed-with-caution kind of swimmer.
Though I understand that diving in will acclimate me to the temperature more quickly, I’d rather shiver and shimmy my way into immersion. And that is also how I buy stocks. Most of us do the same when we invest. We begin with a modest position in a stock and add to it slowly over time. Investors call that dollar-cost averaging, a kind of second cousin to diversification. It is a satisfying approach except that it detracts from total return over time.
Yes, you heard me right. I employ the strategy although I know it hurts my performance. Still, DCA is the preferred approach of most people — especially if they receive a windfall. Putting a large sum of money to work all at once in the stock market is daunting to even the most experienced investor. DCA makes us feel better about investing in the face of uncertainty. And let’s face it, most investing involves uncertainty.
If the market has been strong, we often hesitate to invest all at once because we worry we are buying in at the top just in time for stocks to decline. If the market is weak, we worry it will continue to decline and we will lose our money. By averaging into the market, we are creating a natural hedge. (The most relevant, real-life example of dollar-cost averaging is the investment of our 401(k) contributions.)
DCA is like buying insurance when the dealer shows an ace in blackjack. We choose to give up some of our gains to insure against a loss.
Click here to read more: The Arizona Republic