How to Invest for Retirement – Dollar Cost Averaging
Dollar Cost Averaging is a great way to invest for retirement. It is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. For the majority of us, timing the market is near impossible. It can be extremely stressful and time consuming just trying. A way to avoid that is to invest a constant amount every month.
Let’s say you invest $1,000 every month in stocks. When the market is up, your $1,000 will buy fewer shares, but when the market is down, your money will buy more. This strategy effectively averages out your cost per share. A benefit is that you avoid paying the peak price, but of course also aren’t paying the lowest.
Summary benefits of dollar cost averaging:
- Establishes good investing habits. Setting an investment plan and revising it each year enables you to be disciplined about your investing. Make it an automatic transfer from your checking or savings account, and you can feel good about doing the right thing consistently over time.
- Removes stress. It can be extremely stressful and time consuming trying to time the market and pick its trough. Not to mention highly improbable, no matter how good you are. When you invest a large sum of money in a single trade, for example, you’re more likely to feel regret if that trade turns out to be poorly timed. Behavioral economists note that most people are inherently loss-averse—they tend to react more strongly to losses (or the prospect of them) than to gains. But with dollar cost averaging, you’re investing small sums of money over time, making it easier to stomach a poorly timed investment.
- Minimizing regret. Dollar cost averaging helps ensure that you will at least participate and buy at a price closer to he average. Even if you stop investing when your investments are getting clobbered, and try to jump back in when the suffering is over, most likely your timing will be off.
This approach also helps to remove also anchoring bias. If you bought stock at a historical high, you may be reluctant to sell when prices are low. By dollar cost averaging into a position, you may be less likely to cling to a single price anchor, making it easier to buy and sell according to a predetermined plan.
