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Dollar Cost Averaging: 9 Things You Need to Know

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Dollar cost averaging is a simple strategy that can increase your investment returns and reduce your risk. With this method, an investor purchases equal dollar amounts of an investment regularly over time instead of putting a lump sum of money into the market at once.

Using this strategy minimizes the chance of buying at a high point and can help lower an investment’s average purchase price, increasing an investor’s overall return. Here’s how dollar cost averaging works and nine things you need to know about it.

1. It can protect you against market fluctuations

Perhaps the biggest advantage of dollar cost averaging is the fact that it puts the stock market’s natural fluctuations to work for you.

If you buy in a large lump sum and mistime the market, it can be a long climb out of the hole. But by spreading out your purchases over time, you could avoid putting all your cash in at the top of the market and likely will buy some shares at a lower price. This can reduce your risk and help you buy at an average value over the period of your purchases.

2. Dollar cost averaging can keep you from making emotional decisions

If you commit to dollar cost averaging — buying regularly regardless of the market’s performance — you’ll avoid a temptation that hurts many investors. Some become fearful when the market drops and don’t buy, but when the market rises, they start buying again.

In the end, they pay a higher price than they ought to. Rather than trying to make decisions as the market fluctuates, commit to a regular schedule of purchases and take the emotion out of it.

3. It works best in a falling market

Dollar cost averaging often helps you achieve a lower price for your position. While the strategy really shines when the market’s falling, it can help lower your risk in all markets.

For example, let’s say you buy 100 shares of a $10 stock in a lump sum for $1,000. Your cost basis is $10. If the stock falls to $5, you’re suddenly down $500. Even if the stock later recovers to $7.50, you’re still down $250.

With dollar cost averaging, you take advantage of this drop. Let’s say you split your buys into two $500 chunks. At $10 per share, you spend $500 and receive 50 shares. Then at $5 per share, you spend another $500 and receive 100 shares. Now you own 150 shares with a cost basis of $6.67 per share. When the stock recovers to $7.50, your investment is now worth $1,125 and you’ve made a profit of $125, even though the stock has only partially recovered.

In a flat market, a lump-sum approach and dollar cost averaging produce nearly the same profit, but the investor had to have more money in the market and so took more risk. Meanwhile, the investor using dollar cost averaging had less money in the market, took less risk and had the potential to take advantage if stocks fell.

Even in a rising market, with less money in the market at one time, dollar cost averaging reduces your risk, though it will cost gains that you could have had with a lump-sum approach.

4. It’s a long-term strategy

Dollar cost averaging forces you to think long term. When you’re buying a stock, you want it to be as cheap as possible, and that means hoping for it to go lower before it finally goes higher.

At lower prices, you’ll buy more shares, so when the stock does rise, your gains will be even greater. But you have to think long term and be willing to stomach short-term losses and consider them great buying opportunities.

5. Beware the trading costs

Dollar cost averaging can run up trading costs if you don’t carefully manage how often you’re buying and how many securities you’re using this strategy for.

Purchasing just one or two stocks or funds? You’re probably all right. But pay attention to how often you’re buying. For most people, buying weekly is too much; if you purchase too often, you won’t give the market enough time to move. Biweekly or monthly is a better option for most.

Plus, if you trade too often, fees will eat up money that could be put into stocks. Of course, if you’re using a free trading app, such as Robinhood, those extra trades won’t cost you anyway.

6. Dollar cost averaging makes the most sense for volatile assets

Dollar costs averaging generally makes the most sense for volatile assets because it takes advantage of and protects against price fluctuation. That means the strategy is ideal for stocks, stock-based exchange-traded funds and mutual funds.

It’s likely not a great fit for relatively stable securities, such as bonds or high-yield savings accounts, because they don’t move around as much. These stable assets will move, of course, but over a much longer time frame, so mistiming a purchase is less costly.

7. This method lowers risk, but you could miss out on returns

Dollar cost averaging is a great strategy for individuals and less sophisticated investors, but in a rapidly rising market, this approach is going to cost you. In a rising market, a lump-sum purchase would have worked out better. But that requires timing the market correctly, a risky approach that savvy investors usually avoid. And no one — not even the top professionals — knows which direction the market is headed.

Because of that, it’s usually best to limit your risk, avoid timing the market and take advantage of the market’s drops.

8. Dollar cost averaging can be done automatically

If your idea of a good time is watching the calendar for the right day of the month to buy stock, then make your investments manually. For the rest of us, find a brokerage that’s able to automate the process so you can spend more time on the things you enjoy.

You can set up your account to buy on a preset schedule, and all you’ll have to do is make sure the money is available. Even easier, many brokerages can pull the money right from your bank account.

This automatic approach is great because it keeps your emotions out of the investing process. Instead, set it and forget it.

9. This strategy is the norm for 401(k) programs

Do you contribute regularly to a 401(k) program and invest your contribution in the market? Then you’re already using dollar cost averaging. You’re using the power of automatic investing to continue buying even when the market dips and keeping your emotions out of the decision-making process. It’s the way to be pleasantly surprised when you check your account balance.

Dollar cost averaging doesn’t always lead to maximum gains, but it works well in many situations and can help protect your portfolio from bad outcomes. And because it’s a formulaic purchasing plan, it’s even better for beginning and intermediate investors who don’t want to spend their time thinking about how and when to invest.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

James F. Royal, Ph.D.
James F. Royal, Ph.D. |

James F. Royal, Ph.D. is a writer at MagnifyMoney. You can email James here

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Investing

Should You Pay Off Debt or Save Your Money?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

You have a regular source of income, you’re paying your bills on time and you have some extra dollars left over each month. What should you do with that extra cash?

If you don’t have debt (lucky you!), then the choice is simple — save or invest as much as possible. If you have debt, however, the choice can be a bit murkier: Should you pay off your debt first or save? Here are some things to consider when asking yourself that question.

Three times that saving your money might be smarter

1. If you don’t have an emergency savings fund

Just when you’re cruising along, life can throw some unexpected and expensive curves your way. A sudden job loss, medical bills or car repairs can pop up out of the blue, and if you don’t have the funds to pay for them, you can end up seriously in the red. To cover unexpected costs, some may resort to high-interest credit cards and loans. Those kinds of moves can dig you into a financial hole that can take years to pay your way out of.

Saving up a healthy emergency fund can protect you in instances like these. How much should you save? Experts generally suggest that you should save an amount equal to between three and six months of living expenses. Depending on your individual circumstances, however, you may need more than that. (Check out this article to figure out how much to save and where to keep it.)

2. Your employer offers matching retirement contributions

If you’re fortunate enough to work for a company that offers a retirement plan with matching contributions, then consider making that method of saving a priority.

For example, if your employer offers to match your contributions dollar-for-dollar up to 6% of your salary in a 401(k) plan, then contribute at least that much, if possible. The money can then grow in a tax-free or tax-deferred 401(k) until you withdraw it in retirement — all that compound interest can really add up over the years. If you don’t contribute up to that amount, you’re leaving free money on the table.

Note, however, that If you need to withdraw these funds early (before the age of 59 and a half and before the account is five years old) there will be penalties to pay. That makes this a better tool for long-term savings rather than for the short-term or as an emergency savings fund.

3. Your debt has a very low interest rate

Debt gets a bad rap — often for good reason — but in some cases, carrying your low-interest debt and investing or saving your funds instead may be more beneficial. For example, the current fixed interest rate for direct subsidized and unsubsidized student loans is 5.05%, and the average 30-year fixed mortgage rate is about 4.3%. The stock market, on the other hand, has gone up an average of 10% a year since 1926.

Beyond comparing interest rates, however, you also need to assess how much risk you’re willing to take and how much access to your savings that you’ll need. Of course, there are no guarantees that your investments will perform well, and paying down debt comes with zero risk. Savings accounts are a less risky saving option, but the average interest rate is often less than 1 or 2%. Other options, such as individual retirement accounts (IRAs), have restrictions on how the funds can be used outside of retirement.

Four times debt repayment may be more beneficial

1. You have high-interest debt

It’s hard to get ahead of high-interest debt, because compound interest is working against you. Credit card interest rates, for example, average between 15 and 20% — an amount which adds up quickly. If you make the minimum payment, you may not even be making a dent in the principal amount owed, and you can spend years just paying interest. Calculators like this one can help you figure out just how much interest you’ll pay and how long it will take to pay off.

If you have high-interest debt, make sure you explore all the options for paying it down, including consolidating your debt and researching balance transfer cards.

2. Your debt doesn’t offer any benefits

Though your debt is costing you in interest, you might find that some loans may offer useful perks. For example, federal student loans may offer tax benefits and even loan forgiveness programs for eligible borrowers. Similarly, there are tax write-offs for mortgages and in many cases, the money you invest in a home will pay off down the line when you sell your property.

On the other hand, the debt on the credit card you maxed out to pay for that trip to Cabo comes with no benefits — just a bunch of interest. High-interest debt with no benefits should be at the top of your pay-off priority list.

3. You want to raise your credit score

While there are many factors that go into determining your credit score, the amount of debt you carry is an important component. If you plan to buy a home or secure a loan in the near future, take a look at your debt-to-income ratio (DTI), which many lenders consider before approving you for a loan. If your DTI is high, you may want to consider paying off some debt before applying for that new loan, which may result in lower interest rates for you later.

4. Your debt stresses you out

Debt can take an emotional and physical toll on people, ranging from depression to insomnia and more. When it feels like a black cloud hanging over your head and it’s affecting your life in negative ways, it may be in your best interest to prioritize paying debt off first.

Should you pay off debt or save?

Of course, saving vs. paying off debt early doesn’t have to be an either/or situation — ideally, you can do both at the same time. If, however, a choice must be made between the two, there are many factors to consider. As with most financial moves, there are no cut-and-dry rules, and the best one for you will depend on your individual circumstances.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Julie Ryan Evans
Julie Ryan Evans |

Julie Ryan Evans is a writer at MagnifyMoney. You can email Julie here

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Investing

How to Make Money in Stocks

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Putting money in the market is well-worn financial advice for a reason: Investing in stocks is one of the best steps you can take toward building wealth.But how, exactly, is that wealth built? How is money earned by purchasing stock market holdings, and what can you do to maximize the gains you make from your own portfolio?

How to make money in stocks: 5 best practices

The way the stock market works — and works for you — is as simple as a high school economics class. It’s all about supply and demand, and the way those factors affect value.

Investors purchase market assets like stocks (shares of companies), which increase in value when the company does well. As the company in question makes financial progress, more investors want a piece of the action, and they’re willing to pay more for an individual share.

That means that the share you paid for has now increased in price, thanks to higher demand — which in turn means you can earn something when it comes time to sell it. (Of course, it’s also possible for stocks and other market holdings to decrease in value, which is why there’s no such thing as a risk-free investment.)

Along with the profit you can make by selling stocks, you can also earn shareholder dividends, or portions of the company’s earnings. Cash dividends are usually paid on a quarterly basis, but you might also earn dividends in the form of additional shares of stock.

Micro-mechanics of how stocks earn money aside, you likely won’t see serious growth without heeding some basic market principles and best practices. Here’s how to ensure your portfolio will do as much work for you as possible.

1. Take advantage of time

Although it’s possible to make money on the stock market in the short term, the real earning potential comes from the compound interest you earn on long-term holdings. As your assets increase in value, the total amount of money in your account grows, making room for even more capital gains. That’s how stock market earnings increase over time exponentially.

But in order to best take advantage of that exponential growth, you need to start building your portfolio as early as possible. Ideally, you’ll want to start investing as soon as you’re earning an income — perhaps by taking advantage of a company-sponsored 401(k) plan.

To see exactly how much time can affect your nest egg, let’s look at an example. Say you stashed $1,000 in your retirement account at age 20, with plans to hang up your working hat at age 70. Even if you put nothing else into the account, you’d have over $18,000 to look forward to after 50 years of growth, assuming a relatively modest 6% interest rate. But if you waited until you were 60 to make that initial deposit, you’d earn less than $800 through compound interest — which is why it’s so much harder to save for retirement if you don’t start early. Plus, all that extra cash comes at no additional effort on your part. It just requires time — so go ahead and get started!

2. Continue to invest regularly

Time is an important component of your overall portfolio growth. But even decades of compounding returns can only do so much if you don’t continue to save.

Let’s go back to our retirement example above. Only this time, instead of making a $1,000 deposit and forgetting about it, let’s say you contributed $1,000 a year — which comes out to less than $20 per week.

If you started making those annual contributions at age 20, you’d have saved about $325,000 by the time you celebrated your 70th birthday. Even if you waited until 60 to start saving, you’d wind up with about $15,000 — a far cry from the measly $1,800 you’d take out if you only made the initial deposit.

Making regular contributions doesn’t have to take much effort; you can easily automate the process through your 401(k) or brokerage account, depositing a set amount each week or pay period.

3. Set it and forget it — mostly

If you’re looking to see healthy returns on your stock market investments, just remember — you’re playing the long game.

For one thing, short-term trading lacks the tax benefits you can glean from holding onto your investments for longer. If you sell a stock before owning it for a full year, you’ll pay a higher tax rate than you would on long-term capital gains — that is, stocks you’ve held for more than a year.

While there are certain situations that do call for taking a look at your holdings, for the most part, even serious market dips reverse themselves in time. In fact, these bearish blips are regular, expected events, according to Malik S. Lee, CFP® and founder of Atlanta-based Felton & Peel Wealth Management.

So-called market corrections are healthy, he said. “It shows that the market is alive and well.” And even taking major recessions into account, the market’s performance has had an overall upward trend over the past hundred years.

4. Maintain a diverse portfolio

All investing carries risk; it’s possible for some of the companies you invest in to underperform or even fold entirely. But if you diversify your portfolio, you’ll be safeguarded against losing all of your assets when investments don’t go as planned.

By ensuring you’re invested in many different types of securities, you’ll be better prepared to weather stock market corrections. It’s unlikely that all industries and companies will suffer equally or succeed at the same level, so you can hedge your bets by buying some of everything.

5. Consider hiring professional help

Although the internet makes it relatively easy to create a well-researched DIY stock portfolio, if you’re still hesitant to put your money in the market, hiring an investment advisor can help. Even though the use of a professional can’t mitigate all risk of losses, you might feel more comfortable knowing you have an expert in your corner.

How the stock market can grow your wealth

Given the right combination of time, contribution regularity and a little bit of luck, the stock market has the potential to turn even a modest savings into an appreciable nest egg.

Ready to get started investing for yourself? Check out the following MagnifyMoney articles:

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Jamie Cattanach
Jamie Cattanach |

Jamie Cattanach is a writer at MagnifyMoney. You can email Jamie here

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