When I hit a point in my life where I finally realized the value of investing and educating myself in investing, one of my biggest worries was understanding how to approach market fluctuation and get in “at the right time”.
I heard so many stories of people hitting it big because they invested in a particular company at the right time. How would I ever have a strong enough grasp on all of the businesses out there to know when and what to invest in?
Over the course of my first forays into investing, and a pitiful experience with Robinhood, I came to learn that the concept of timing the market was essentially just gambling. No one really knows what’s going to happen when. Just like no one could have predicted a pandemic in 2020 that sent the stock market crashing.
The stock market is known to fluctuate substantially, with its value rising and falling on a regular basis. While this volatility may make some investors wary, it also presents an opportunity for those willing to take the risk.
If you’re dipping your toe into the world of investing but are worried about how to capitalize on the fluctuations, consider employing a dollar cost averaging strategy.
What is Dollar Cost Averaging?
Dollar cost averaging is the process of purchasing the same amount of shares at a regular interval across different investment periods, regardless of the price of the share at the time of purchase.
The economy is by nature periodic, with the ebbs and flows of the market, the price of shares is always unpredictable. Thus, it is impossible to determine the ideal time to invest. By investing through a dollar cost averaging strategy, investors can protect themselves against making costly mistakes based on their emotions rather than facts. Dollar cost averaging enables investors to invest a set amount of money on a regular basis, regardless of the current share price. Investors may choose to invest the same amount of money each month, week, or even day. Dollar cost averaging can be beneficial for investors who are risk-averse and want to minimize their downside risk when investing.
Dollar Cost Averaging vs. Lump Sum Investing
Contrary to dollar cost averaging, lump sum investing is when you invest a large sum of money all in one go. Many of us have scenarios in our lives when we receive cash as a sum – tax returns and bonuses being the most common.
A dollar cost averaging approach would have you spread your investments from this lump sum out over time. While it holds true that this would reduce risk of investing when the market is high and having to deal with short term losses, I don’t recommend it.
Why? Because we’re human. Most of us will end up spending the money. So unless you are super-human, I recommend going ahead and moving forward with lump sum investing in the scenarios.
How to use a Dollar Cost Averaging Calculator
Dollar cost averaging can be used at any point in the investment cycle, whether you’re just getting started with investing or are looking to add to an existing portfolio. Regardless of where you’re at with your investing, a dollar cost averaging calculator can help you make good decisions about the amount of money to invest over a period of time.
Before using a dollar cost averaging calculator, assess your risk tolerance and your goals. Once you have your feet on stable ground with where you’re at and where you want to go, you’ll be able to more confidently employ a dollar cost averaging calculator.
Note that most of these calculators are not called dollar cost averaging calculators. However, by inputting your planned contribution rates, and whether you’ll be investing on a monthly or annual basis, you are essentially simulating a dollar cost averaging strategy.
You will also be asked your expected return rate. I always learned that 7% is a reasonable return to expect, year over year. However, if you want to be more conservative you could drop down to 6%. I would not recommend assuming more than 10%, as 10% is the average rate of return for the entire stock market over the last 100 years.
Best Free Online DCA Calculators
Merrill Edge’s Dollar Cost Averaging Calculator – As I started going through the tools that come up first on Google Search results, this was the first tool that actually worked AND made sense. I really like the results page, where the calculator breaks down total investment, total return and annualized return percent. That being said, the inputs involve guessing the stock prices by month, which is both unrealistic and not conducive for long time investors.
Best for: Looking back at your returns from the past year on a given stock
Noel Whittaker’s Dollar Cost Averaging Calculator – I like the simplicity of this tool.
Simply input when you started investing, how much you’ve invested per month and you’ll receive a total invested and a total return based on a predetermined index. The downside is that this tool is only meant to look backwards, not help with planning, and since the index is decided for you, your individual portfolio construction isn’t taken into account.
Best for: looking back at how your investments would have performed to help you think about what you want to do going forward.
Calculator.net’s Investment Calculator – this is the tool that I always come back to when investment planning. I know it’s not called a dollar cost averaging calculator, but since you can input your monthly investments, it works the same way. I like that I can control the assumed return and that a chart is provided to look at how the interest compounds.
Best for: Planning for the long term
Nerdwallet’s Compound Interest Calculator – I love nerdwallet. It was the first place I started going to access information on financial management and will always have a special place in my heart. This calculator is also not specific to dollar cost averaging, but works much the same way. It’s similar to calculator.net, but simpler. I like that I can play with the assumed rate of return and immediately view the different total return at the end.
Best for: Long term planning, with a simple user interface
Build your own calculator in excel – While this method takes more time, and if you’re like me, more than a few Google “how to in excel” searches, it’s also the best way to start having a running analysis of your investments that is your own. You can have a one stop shop to calculate dollar cost average, compound interest, net worth and anything else you want to track to keep your finances in order. The other benefit of having something that’s your own is the numbers don’t disappear once you exit the page, you are able to check back in over time to see if you’re on track.
Best for: building a bespoke financial management engine of your own
While investing in the stock market can be risky, it can also be very profitable. By using a dollar cost averaging calculator, you can take the emotion out of investing and make calculated decisions based on facts rather than fear. This will help you protect yourself against making costly mistakes by investing too much or too little at the wrong time.