How Dollar Cost Averaging Can Help Reduce Risk In Your Investment Portfolio

Investment portfolios can be a challenge to manage, especially when it comes to balancing risk versus reward. One way to approach this is to use dollar cost averaging (DCA), which can help reduce the risk of overexposing your portfolio to market downturns.

Dollar-cost averaging is an investment strategy where investors purchase a fixed dollar amount of an asset periodically but on a schedule. This approach allows investors to acquire more shares when the price is low and fewer shares when the price is high, which has proven time and time again to favor the investor as it lowers their cost basis (or average purchase price).

Here are a few other ways in which dollar cost averaging can help reduce risk in your portfolio.

Creating Balance

Although having that one asset you favor isn’t negative, intelligent investors have always promoted diversification throughout history – and DCA could also help you here.

DCA helps create a diversified portfolio, as investors will be exposed to different securities over time. This helps ensure that the portfolio is not overly exposed to any particular sector within your market.

A savvy way to continue accumulating your favorite asset while spreading the attention around to others is to toggle your DCA purchases from one investment to another.

You could even purchase multiple assets with such a strategy. While this was a manual process just a short time ago, you can now automate the process thanks to the creation of tools such as a DCA trading bot.

Avoiding Traps

Just as it occurs in a retail environment, sales also happen in the trading world, and who doesn’t love a good deal?

The problem for most investors is that these “sales” can end up being the first out of multiple legs down and can cause a trader to be vested in a trade longer than they’d prefer.

This also is one of the top reasons savvy investors recommend this strategy, especially for those newer to the world of trading and investing in general.

With the use of the DCA method, the investor already knows their game plan and what actions to and not to take. It creates balance and brings clarity in times when emotions and adrenaline are running high – which leads to the next point.

Not Just Monetarily

Dollar-cost averaging can also minimize the emotional stress associated with investing. By committing to a regular schedule of purchases, investors can avoid making impulsive decisions based on short-term market fluctuations.

This factor is usually highly overlooked by traders, but controlling one’s emotions and trying to remain neutral is one of the biggest keys to becoming a successful trader.

Like most other things in life, having a plan in trading creates clarity by removing the thousands of what-if questions and scenarios that may present themselves to you at any time of the day.

Over time, these questions can significantly weigh you down to the point where it becomes overwhelming. Even when using automated systems, as a trader, your mind and the ability to evaluate, process, and take action based on information is your most incredible tool.

Tracking

Tracking your trades provides many benefits in terms of growth as a trader, as well as keeping order and making things easier for you come tax and reporting time.

Honing your craft as a trader comes down to trial and error, identifying the error, and then making adjustments to you or your strategy before trying again – this would not be possible without tracking your performance and having the numbers (results) to learn where improvements are needed.

If you’re following a systematic and consistent DCA strategy, collecting the data needed to file your taxes accurately should be more accessible. This includes purchase lots, the date, investment size, and the position and quantity.

Why DCA

Overall, dollar cost averaging is a great way to reduce risk in an investment portfolio while still keeping the potential for rewards. By committing to a regular schedule of purchases and creating a diversified portfolio, investors can help ensure that their portfolio is well-balanced and prepared for any market volatility.

More importantly, it provides an excellent opportunity for traders to learn how to adapt and implement new tools and strategies into their arsenal, which will only grow with their experience.