For those unfamiliar with dollar cost averaging, the investing strategy aims to reduce variance when buying (or less commonly selling) a security. It involves buying shares of a security in intervals over time rather than buying the full batch at once.
You want to buy 50 shares of XYZ and the share price today (Day 1) is $10.00. If you were to execute this trade in full today, it would cost you $500.00. In this example, let’s assume on Day 5, the price of the stock falls to $9.00; Day 10 the price rises to $10.25; Day 15 the stock dips to $9.75; and finally at Day 20 the price stands at $10.50.
Had you purchased all 50 shares on Day 1, your initial investment of $500.00 would be worth $525.00 on Day 20. That’s a 5% ROI. Not bad, right? Now lets determine how much you would have paid if you had purchased 10 shares on every fifth day.
Day 1: $10.00 x 10 shares = $100
Day 5: $9.00 x 10 shares = $90
Day 10: $10.25 x 10 shares = $102.50
Day 15: $9.75 x 10 shares = $97.50
Day 20: $10.50 x 10 shares = $105.00
You would have paid a total of $495.00, but your 50 shares would still be worth $525.00 on Day 20. That’s a 6.1% ROI. Even better!
This example does not take into account commission fees on your buy orders. This is why dollar cost averaging often doesn’t make sense for those investing with relatively little money. If you were paying the typical commission fee ranging from $5.00 to $10.00 your run of the mill online brokerage charges, dollar cost averaging probably doesn’t make sense.
So what do you do?
Start Trading on Robinhood:
Robinhood is a relatively new innovative broker that charges zero commission fees for most trades. This means you can dollar cost average even if you are buying or selling a limited number of shares with low share prices. Account setup is incredibly simple and the interface is clean and easy to use. There are also no fees associated with depositing or withdrawing funds from the Robinhood. If you plan on dollar cost averaging, or trading in general, I highly recommend going with Robinhood.
Currently, the service is only available on smart devices, though they plan on offering a full featured website in the future. Robinhood also doesn’t have the research and analysis features that online brokers usually offer. Still, you can conduct your research elsewhere online and then make your trades using the app. Additionally, when you exit your position on Robinhood, there is generally a three-day waiting period until you will see the funds in your account. This may limit your ability to trade quickly, however this is a small price to pay for commission free trading.
Sign Up for the Acorns App:
The investing app Acorns automatically invests the change from your debit card purchases. So if you spend $3.24 on a cup of coffee, the remaining 76 cents gets invested in your choice of five portfolios the service offers. This is effectively dollar cost averaging, as Acorns invests your spare change over intervals of time avoiding the commission costs typically associated with buying and selling securities. The amount invested depends on how often you make purchases on your card and you have less control over your investment decisions. You can get around this limitation by setting automatic deposits as well. Either way, you get the benefit of reduced variance by investing small amounts spread out over time.
There are only five investment options. The portfolio choices range from conservative to aggressive; with the conservative portfolios being more bond heavy and aggressive more stock heavy. You cannot pick and choose individual securities, but you can buy into a portfolio that generally conforms to your overall risk tolerance. Lastly, with the spare change approach, you do not decide on the intervals in which you contribute to your portfolio, as the funds are deposited only when you make purchases and the change totals $5.00.
Dollar Cost Average with Less Frequently:
Instead of buying 100 shares in ten batches of 10 shares each, buy five batches of 20, or even just two batches of 50 shares. Something is better than nothing when it comes to dollar cost averaging. If you are using a discount online broker such as TradeKing or Fidelity, you want to account for commission fees associated with buying securities and need to weigh the benefit of dollar cost averaging with the fees you pay for each purchase. If you already have built up a substantial personal account, these services offer a variety of features that Robinhood and Acorns don’t have. I recommend TradeKing in particular.
The point of dollar cost averaging is to reduce variance and smooth out your entry into or exit from a position. If you can only buy two or three batches due to commission fees limitations, you may suffer from increased volatility.
Buy a Larger Batch if the Price Dips:
Timing the market is difficult, very difficult. However, the old adage “buy low sell high” is sound, albeit oversimplified advice. When dollar cost averaging on a limited budget, if the stock takes a dip, you may consider buying more shares than you had planned for at whatever intervals you had initially set up. This is also known as averaging down. Generally though, you want to stick to your buying schedule, which takes the emotional aspect out of the decision making process and forces you to stick to your goals.
Even if the stock dips, you cannot be sure it won’t dip further, which is the point of entering into your position in several batches in the first place. Also, if the stock goes up in value, you cannot implement this approach. That’s not entirely a bad thing however, since you will have already increased your equity if this occurs.