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:

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 businessman looking at his digital tablet or strategy planning in hotel conference lobby. He is happy at achieving financial goals.
Dividend Investing

5 ASX dividend stocks to buy now

Income investors might want to check out these shares that analysts are tipping as buys.

Read more »

Middle age caucasian man smiling confident drinking coffee at home.
Dividend Investing

2 ASX dividend shares predicted to pay huge yields in 2025

Here are two stocks forecast to have generous payouts next year.

Read more »

a happy investor with a wide smile points to a graph that shows an upward trending share price
Growth Shares

5 top ASX growth shares to buy in April

Analysts think growth investors should be buying these shares.

Read more »

Man holding out Australian dollar notes, symbolising dividends.
Dividend Investing

Buy BHP and these ASX 200 dividend shares

Analysts think income investors should be snapping up these dividend shares.

Read more »

A young woman lifts her red glasses with one hand as she takes a closer look at news about interest rates rising and one expert's surprising recommendation as to which ASX shares to buy
Blue Chip Shares

These ASX 200 shares could rise 25% to 35%

Analysts believe these shares could rise strongly from current levels.

Read more »

Man smiling at a laptop because of a rising share price.
ETFs

How does direct indexing compare to buying ASX ETFs

Do you like index investing, but want more say in which stocks you pick?

Read more »

A woman in hammock with headphones on enjoying life which symbolises passive income.
Dividend Investing

Invest $20,000 in ANZ shares and get $1,200 in passive income

Can investors rely on ANZ for a 6% yield in their cash?

Read more »

Senior man wearing glasses and a leather jacket works on his laptop in a cafe.
Dividend Investing

Why your retirement income may take a hit — and what to do about it

Lower dividend payments doesn’t need to mean disaster.

Read more »