Step By Step: How Dollar Cost Averaging Can Help You Reduce Investment Risk
Published August 31, 2022 • 3 Min Read
For one RBC marketing director, dollar-cost averaging takes the guesswork out of investing – and affords her some peace of mind in times of uncertainty.
“Over time, you don’t lose control regardless of the market conditions,” she says, since it helps keep emotions out of her decision-making process. “Plus, instead of purchasing everything at once, you can ease your way into an investment.”
Averaging out cost per unit
So what’s dollar-cost averaging, exactly?
It’s really a simple investing strategy that can help you reduce the risk that comes with trying to time the market – and ensures you’re putting your money to work for the long-term no matter the short-term market noise. Ultimately, it involves investing a fixed dollar amount, say $25, $50 or $500, on a regular basis, be it bi-weekly, monthly or quarterly, regardless of market conditions.
The idea is that while you will pay more for some of your investments (when markets are rising), and less for others (during market downturns), the overall amount per share will average out in the end – and ideally will total less than you would have paid had you purchased at one set price.
To see how it works, consider this scenario. You decide to invest $500 every month. The table below explains how your investment will fare when markets fluctuate over a three-month period.
| Time | Dollar Amount | Unit Price | # of Units | Total Units |
|---|---|---|---|---|
| Month 1 | $500 | $50 | 10 | 10 |
| Month 2 | $500 | $100 | 5 | 15 |
| Month 3 | $500 | $25 | 20 | 35 |
The above example is for illustrative purposes only.
In this example, you end up paying, on average, $42.80 per unit ($1500/35 units=$42.80) – well below what you would have paid if you purchased all 35 in month two.
Automatic saving
The appeal of dollar-cost averaging goes beyond risk control. By committing a fixed amount for a time, you’re essentially taking control of your own finances. It’s not unlike budgeting, but you’re doing so with the potential to grow your wealth over the long term – in a way that helps protect you against market turmoil.
The psychology behind dollar-cost averaging
It’s natural to feel anxious as markets fluctuate wildly. But how the market is faring should be less of a concern when you dollar-cost average since it can take the emotion out of your investing decisions. It’s impossible to time the market, and dollar-cost averaging means you don’t have to try.
Dollar-cost averaging choices
There are many investment options that work well with dollar-cost averaging, including exchange-traded funds (ETFs), mutual funds and stocks. If you’re hesitant to jump into the markets all at once with a lump-sum amount, or are new to certain investment vehicles, dollar-cost averaging could be a great way to get started.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.
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