Dollar cost averaging has many other names like cost average effect, incremental averaging, and unit cost averaging. It is also referred to as pound cost averaging in the United Kingdom. The basic goal of this investment strategy is to minimize the effect of unpredictability while purchasing or investing in an instrument or large financial asset. The DCA strategy does not invest in or purchase the instrument or asset with the capital lump-sum amount. The investment gets divided into smaller amounts and these amounts are separately invested at regular predetermined intervals. The investment goes on until the complete capital amount is exhausted. Dollar Cost Average lowers the average investing cost to reduce volatility.
Reduction of risk
When it comes to investing, there is always the fear of a market crash. Pound cost average preserve the capital in order to avoid this situation. The price of a security is artificially inflated because of market sentiment. At this point of time, DCA enables buying a significantly lower quantity of security. The investor’s portfolio will decline with the security price discovering the intrinsic price through bubble bursts or market correction. The downturns get prolonged which diminish the net worth of the portfolio. An investor, who uses DCA, can ensure possible high returns and minimum losses. With short-term provision, DCA helps with protection against a security price’s swift deterioration. The potential of long-term portfolio return gets significantly boosted as the market rises.
An investor can ensure higher returns when market securities are bought during declining prices. DCA makes sure that you buy more security with a low price than with a higher price.
Preventing bad timing
Even professional investors fail to master the market timing. Investing a huge amount at the wrong time will result in risks. As these swings cannot be predicted, smoothening out the cost with DCA helps the investor to gain benefits.