Excuse me for making a post title that is quite a mouth full if you are not used to terminology that stock market investors use. I am not trying to look smart, I just want to explain how you can slowly buy into a company without feeling too much pain from price fluctuations in the stock market.
The picture above shows a graphical representation of the price of Tesla stock from March to July 2020. If you were able to buy shares in the dip in March the cost for one share would have been around $350, while today, early August, it is at $1431. And Tesla is not the only one moving up and down so fast, this so-called volatility can be found in many companies as COVID-19 plus economical changes made the entire stock market very nervous.
So what to do when you want to buy Tesla? Which day and time would be best? The price has gone up so far, it must come down, but when? And what if Elon Musk presents another technological miracle and the price only goes up for months, when will you make that money work for you? A part of the answer is DCA, or dollar-cost averaging.
What you basically do is this: you do not buy a full Tesla share today but instead buy a little part of it on a regular basis, averaging out any price fluctuations as you go. An example might look like this:
Your 1st purchase is small to test the waters, so you buy about 0.03 shares of Tesla and pay $50 for that fraction. The 2nd time you see a lower price plus you got your mind set on it, so you drop $100. The 3rd time you see Tesla made a large price drop and is right where you want it to be, so you buy a full share for a little over $1289. Later, when the price has gone up, you go back to a careful purchase using only $50. In the end, you own 1.13 of Tesla for an average price of $1313 per full share.
Of course you can always buy in for the same amount no matter what the price is (which would be the pure definition of dollar-cost averaging), but I tend to give it some extra when I feel the price is extra nice on a certain day.
Using DCA, you protect yourself from buying shares at a price that later turned out to be way too high, while also being in the market and possibly making some profit instead of waiting forever with your cash doing nothing for you.
DCA is a good strategy for investors with a long-term horizon that are looking to lower their risk of buying too high. Of course it does not guarantee profits as the stock price may keep falling and never come back to what you paid on average. Also, if you DCA into a company that is about 95% certain to go up for a long time ahead, the more you buy at the start the more you will profit in the end.
If you however want to take some emotion out of investing, want to avoid bad timing and think long-term (years ahead) it can be nice to dollar-cost average your way to the moon (and beyond)…
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