If you're already contributing money to a 401(k) retirement account, you may not have realized it, but you're practicing a popular investment strategy known as dollar-cost averaging.
Simply put, this approach means you're investing fixed, equal amounts on a regular basis, say monthly or bi-weekly, rather than investing one lump sum of cash all at once.
With a defined 401(k) contribution plan, for example, you're investing as you earn, regularly taking money from each paycheck throughout the year and putting it into the market. Dollar-cost averaging could also look like if you decide to invest $5,000 of your savings by splitting that cash into five parts, where $1,000 is invested each month for five months.
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Dollar-cost averaging allows you to spread out your investments and buy into the market at different times at varying prices. In turn, these purchase prices ideally balance each other out, which is where the "averaging" part of the phrase comes from.
Experts often recommend this long-term investing approach (especially with broad market-tracking index funds) to people with low-risk appetites since contributing cash consistently over time reduces the impact of any market volatility on an investment. Not to mention, it allows investors to forget about the up and down movements of the market since their contributions aren't influenced by what's happening; they're making contributions at regular intervals no matter what. This helps leave emotion-based investing off the table.
Dollar-cost averaging is often compared with its antithesis, lump-sum investing, an opposite approach otherwise known as simply timing the market.
Like dollar-cost averaging, lump-sum investing can also help you build wealth — and even better, maximize your returns — albeit with the caveat that you're taking on much more risk. After all, as we all know, no one can really time the market.
When investing a big wad of cash into the market all at once, your money gets put to work immediately. With dollar-cost averaging, however, only some of your money goes into the market to start and the rest is set aside for future contributions — this could allow you to catch future dips in the market, but your immediate gains may be smaller if the market takes off sooner than expected.
When investing with any method or strategy, the first step is to identify the potential returns as well as your risk tolerance.
Though you may get better returns over time with lump-sum investing, it's not a good idea for those looking to lower their short-term downside risk since the potential for loss is greater.
Risk-averse investors, or those worried about market volatility, are better off using the dollar-cost averaging investment approach. A good place to start is with an S&P 500 index fund which has shown an average annualized return of approximately 10% since 1957.
For example,Charles Schwab'sS&P 500 Index Fund is a straightforward option with no investment minimum. Its expense ratio is 0.02%, meaning every $10,000 invested costs $2 annually — index funds generally have a 0.2% expense ratio, so this is notably low.
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Minimum deposit and balance requirements may vary depending on the investment vehicle selected. No account minimum for active investing through Schwab One®Brokerage Account. Automated investing through Schwab Intelligent Portfolios® requires a $5,000 minimum deposit
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For an option with no expense ratio, consider the Fidelity ZERO®Large Cap Index Fund. Though the fund doesn't technically track the S&P 500, the Fidelity U.S. Large Cap Index tracks large capitalization stocks, whichthe website says, "are considered to be stocks of the largest 500 U.S. companies."
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Minimum deposit and balance requirements may vary depending on the investment vehicle selected. No minimum to open a Fidelity Go®account, but minimum $10 balance according to the investment strategy chosen
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You can also consider investing a fixed monthly amount through a robo-advisor like Betterment, which will create a custom portfolio of ETFs (which are similar to index funds) for you based on your risk tolerance and investing horizon.
Minimum deposit and balance
Minimum deposit and balance requirements may vary depending on the investment vehicle selected. For example, Betterment doesn't require clients to maintain a minimum investment account balance, but there is a ACH deposit minimum of $10. Premium Investing requires a $100,000 minimum balance.
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As an investment enthusiast with a deep understanding of financial strategies, let's delve into the intricacies of the article on dollar-cost averaging. The article provides valuable insights into this popular investment strategy and its comparison with lump-sum investing. I'll provide a comprehensive breakdown of the key concepts covered:
Dollar-Cost Averaging (DCA):
- DCA involves investing fixed, equal amounts at regular intervals, such as monthly or bi-weekly.
- This strategy is commonly practiced in 401(k) retirement accounts, where contributions are made consistently over time.
How DCA Works:
- DCA allows investors to spread out their investments, purchasing assets at different times and prices.
- The averaging effect helps balance out purchase prices over time, mitigating the impact of market volatility.
Long-Term Investing Approach:
- Experts recommend DCA, especially with broad market-tracking index funds, for individuals with low-risk appetites.
- Consistent contributions over time reduce the impact of market fluctuations, and emotional investing is minimized.
DCA vs. Lump-Sum Investing:
- DCA is contrasted with lump-sum investing, where a large amount of cash is invested all at once.
- While lump-sum investing can offer immediate gains, it comes with higher risk, as market timing is challenging.
- Investors are advised to assess their risk tolerance and potential returns when choosing between DCA and lump-sum investing.
- DCA is recommended for risk-averse individuals or those concerned about short-term downside risk.
Suggested Investment Vehicles:
- The article suggests the use of S&P 500 index funds for DCA, highlighting Charles Schwab's S&P 500 Index Fund with a low expense ratio of 0.02%.
- Another option mentioned is the Fidelity ZERO® Large Cap Index Fund, which doesn't track the S&P 500 but includes large-cap U.S. stocks.
Alternative Investment Strategies:
- The article introduces robo-advisors like Betterment as an alternative for DCA, creating custom portfolios based on risk tolerance.
Considerations for Different Investment Vehicles:
- Minimum deposit and balance requirements may vary based on the chosen investment vehicle, such as Charles Schwab or Fidelity.
- Fees associated with these investment options are discussed, with a focus on low-cost index funds.
- The article emphasizes the importance of understanding investment options and suggests utilizing extensive tools and research from providers like Charles Schwab, Fidelity, and Betterment.
In conclusion, the article provides a well-rounded overview of dollar-cost averaging, its benefits, and considerations for investors, backed by information on specific investment vehicles and alternatives.