A guide to using the dollar-cost averaging strategy

A guide to using a dollar-cost averaging strategy that will protect your portfolio from market volatility in the current economic climate.

| More on:
Piggy bank wrapped in bubble wrap

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Many investors leap into the share market with a lump sum amount hoping that all of their new ASX shares will rise. Unfortunately, this is hardly the case. While some ASX shares will indeed be in positive territory, chances are there will be a few in the red.

Without doing the proper research on the shares beforehand, you are exposing yourself to a great risk of it falling in value. It pays to have a plan of attack to protect your portfolio should your quality share drop in value due to small company hiccups or macroenvironmental factors.

Thus, enter the dollar-cost averaging strategy (DCA).

What is dollar-cost averaging?

DCA is a simple strategy that involves investing an amount of funds in the same ASX share at regular intervals over a period of time.

For example, say you invested $1,000 in Zip Co Ltd (ASX:Z1P) shares at $6.00 a piece. You would own 166 shares of Zip shares. If the share price of Zip fell by 10% (to $5.40) after you had bought the shares, the current value would be $896.40.

Now, some investors may be happy to just wait until the Zip share price goes back past $6.00 again before possibly selling or just sit on their original investment for the long term. However, if you employed a DCA strategy, when the Zip share price falls to $4.00, you might possibly buy another $1,000 worth. You would then have your original 166 shares plus an extra 250 shares from your latest investment.

This would total 416 Zip shares at a cost basis of $4.80. It may not seem like much, but this 20% discount is just from your first regular investment interval. Eventually, you would smooth out your purchase price over time and ensure you’re not dumping your money into the one share at a high price point.

DCA reduces the impact of market volatility on the overall purchase. It is known as a risk-reduction tool and can be very effective, especially in uncertain climates like the one we currently face.

It’s worth considering, however, that if you are buying Zip shares at regular intervals and the price keeps going up, you will be increasing your cost basis and essentially getting less value than if your had initially purchased all the shares at once. Similarly, should the Zip share price keep falling and not recover at all, DCA would not be a wise strategy to implement.

Foolish takeaway

DCA is suited to investors with a lower risk tolerance and a long-term investment horizon.

I apply the DCA strategy across most of my ASX share purchases and have done pretty well with it. 

Tiptoeing in small increments during a market dominated by COVID-19 news will protect your portfolio and help to avoid slumps. Obviously there is no guarantee of good returns on any investment, and it is still important to research any company you wish to own a part of.

But overall, I believe company research and using the DCA strategy is a great way to build serious wealth.

Aaron Teboneras has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of ZIPCOLTD FPO. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Investing Strategies

A man thinks very carefully about his money and investments.
Investing Strategies

$20,000 invested in these ASX shares 10 years ago is worth how much now?

These ASX shares have generated strong returns over the last 10 years...

Read more »

Workers wearing COVID protections mask bump elbows,indicating business still goes on
Broker Notes

3 ASX 200 shares to buy for a post-COVID resurgence: experts

The coronavirus is still going strong, which means many post-pandemic recovery stocks have yet to reach their full potential.

Read more »

a group of five people lie on the floor with their heads touching, each wearing hi tech goggles over their eyes as if in a metaverse workplace collaboration.

How to buy ASX shares exposed to the metaverse

A new product launched Thursday that collectively invests in a basket of stocks around the world contributing to a new…

Read more »

woman about to eat a burger
Investing Strategies

‘Free lunch’: Forget growth or value, Wilsons is hunting these ASX shares

Quality ASX shares are the next craze. Here's how to spot them, according to head of investment strategy David Cassidy.

Read more »

Two boys in business suits holding handfuls of money
Investing Strategies

‘Forgotten gem’: 2 mid-cap ASX shares this fundie loves

When interest rates are rising steeply, cash flow is paramount. Here's a pair of stocks that are self-sufficient this way.

Read more »

A discussion between colleagues using a laptop.
Investing Strategies

5 things to do during ASX results season

August and February can be hazardous for unseasoned investors. Here's a survival guide.

Read more »

Woman puts heads back and fists in the air as she cheers at laptop
Investing Strategies

ASX shares are back, baby!

Stock markets plunged in the first half of this year out of various economic fears, but now there's a massive…

Read more »

A male investor sits at his desk looking at his laptop screen holding his hand to his chin pondering whether to buy Macquarie shares
Broker Notes

‘Superior growth outlook’: ASX share raking it in from climate change

This stock has already returned 510% the last five years, but there is more to come, according to many experts.

Read more »