Pros
Reduces Emotional Component
- One advantage to dollar/pound cost averaging is that by investing mechanically, you will take the emotional component out of your decision-making. You will continue on a preset course of buying a certain dollar amount of your preferred investment irrespective of how wildly the price swings. This way, you will not bail out of your investment when the price goes down in a wild swing, but rather see it as an opportunity to acquire more shares at a lower cost.
Avoids Bad Timing
- If you invest your money all at once in a particular investment, there is the risk that you will invest just before a big market downturn. Imagine you had jumped into an investment just before the market downturn that began in 2007. You would have ended up losing more money than if you had invested only some of your money before the downturn.
Cons
Market Rises Over Time
- A disadvantage of dollar/pound cost averaging is that the market tends to go up over time. This means that if you invest a lump sum earlier, it is likely to do better than smaller amounts invested over a period of time. The lump sum will provide a better return over the long run as a result of the market’s rising tendency.
Not a Substitute for Identifying Good Investments
- Dollar-cost averaging is not a solution for all investment risks, however. You will have to take on the task of identifying good investments and do your research even if you opt for a passive dollar/pound cost averaging approach. If the investment you identify turns out to be a bad pick, you will only be investing steadily into a losing investment.
- Also, by adopting a passive approach, you will not be responding to the changing environment. As the investment environment changes, you might get new information about an investment that might want to make you rethink your approach.
- For instance, if you hear that XYZ company is making an acquisation that will add to its earnings, you might want to increase your exposure to the company. However, a dollar/pound cost averaging approach does not allow for that sort of dynamic portfolio management.
