Dollar Cost Averaging

Since it is impossible to time the market, if you divide and invest your capital in fixed intervals using the dollar-cost averaging strategy, you can avoid the risk of investing all the capital when the market valuation is high.  It is a good strategy for one to invest across a long period horizon.

Dollar-cost averaging works well in a volatile market.  In the example below where one would invest $10,000 per year in a specific fund for 5 years, the strategy actually performs better in scenario 1($61,667) where the price of the fund fell first and then bounce back to finish at where it started than scenario 2($59,163) where its price of kept rising and finishes 40% higher.  In a volatile market like scenario 1, the strategy allows you to buy more shares when the price falls and contributes to the outperformance.

Another extreme scenario is investing in the Japanese market between 1989 to 2009 when the index fell nearly 80% from its peak and dollar-cost averaging also lets you buy more shares at a lower price.   As the overall global markets enjoyed a healthy rise over the same period, investing in a globally diversified portfolio would help as it reduces concentrated market risk.

Summary

Dollar-cost averaging works well in a volatile market and helps you avoid investing all your capital at a high market valuation.  Combined with a globally diversified portfolio and compound interest effect, you will likely enjoy a healthy return over a long period investment horizon.

Last update: 16th June 2022