Averaging up refers to the practice of investing in a particular stock when that stock price or portfolio is increasing. As the average price of the stock or portfolio trends upwards, the investor continually buys stock. Averaging down is the same practice, except stock prices are decreasing. Averaging up and down is typically associated with dollar-cost averaging, which is a strategy for maximizing stable returns over the long term. Dollar-cost averaging is an investment strategy where an investor purchases assets over several years using a set amount of money for each investment.
Anyone who has watched a movie or television show featuring a storyline involving investment strategy or financial advisors has heard the classic phrase “Buy Low, Sell High.” This is an overly simplistic way of explaining that one should invest when the price of a stock is low. When the stock price or asset price is considered high, one should sell. It’s a simple strategy to take advantage of the stock price’s upward movement.
However, those looking for a more nuanced and comprehensive approach should consider dollar-cost averaging. When determining the advantages of a dollar-cost averaging strategy over the long term, it’s important to understand what averaging up is and why can be advantageous for some investors.
What is dollar-cost averaging?
Dollar-cost averaging is a strategy of drip-feeding capital into the market over a long time. Whether it is investing in individual stocks, mutual funds, or ETFs, dollar-cost averaging is a strategy applicable to all market investments.
For example, let’s say you have an initial investment of $100,000 in capital. You might be tempted to put the lump sum directly into the stock market or in a particular stock. For those that enjoy gambling, with games like blackjack and roulette, this might seem like a great strategy. It provides as much adrenaline as possible while betting on a rising stock.
However, it doesn’t take into account the volatility that exists in the market over the longer term. For those looking for more stable and long-term returns, it’s better to drip-feed that $100,000 over time. For example, rather than investing all $100,000 at one time, you can invest $10,000 per year over 10 years.
Is averaging up better than averaging down?
Not really—both should be utilized when implementing a dollar-cost averaging strategy.
What are the benefits of dollar-cost averaging?
The benefits of a dollar-cost averaging strategy include riding the market’s volatility over the long term, assuming that the stock price and market will eventually be higher.
Regardless of whether the stock price or market is moving up or down, you continue to invest the same amount every month or year. This allows you to take advantage of volatility in the market by averaging down and investing with a more risk-averse strategy, than when the market is booming by averaging up. You will continue to invest regardless of if the new stock price is higher or lower than the previous purchase price.
Is it better to dollar-cost average or invest a lump sum?
There isn’t a one-size-fits-all answer to this question. A lot depends on what type of investor you are and the how the market (and assets) you’re investing in. Here we can see the comparison between a lump sum investment and dollar-cost averaging over time.
In this example we compare a $12,000 lump-sum investment and a $1,000 a month dollar-cost averaging strategy from December 2019 to December 2020. The asset we are using is SPY, an ETF that tracks the S&P 500 index.
This graph illustrates that lump sum investing can be a smart decision with better returns over the short term if the market is in an upward trend. However, the losses are higher than when dollar-cost averaging in a bear market. On the other hand, over the long term of 10 or more years, the dollar-cost averaging strategy may generate a higher return. This is because dollar-cost averaging allows you to pay an average purchase price for the stock. The average purchase price should be somewhere between the highest and lowest points of the stock price. This average price is ascertained through the process of averaging down and averaging up.
If you prefer to avoid the market’s volatility, then dollar-cost averaging could be a great investing alternative. But that doesn’t mean it’s guaranteed to produce better returns. In fact, one study found that lump-sum investing outperformed dollar-cost averaging 75% of the time. While it’s certainly a strategy to consider, dollar-cost averaging is not fore everyone.
Want more information on how to best utilize the concept of dollar-cost averaging in your portfolio? Here is a list of advisers who will have dollar-cost averaging structures for you to take advantage of.
The name of the game in averaging up is taking advantage of upward stock market momentum by continually investing or drip-feeding money at regular intervals.
This allows the investor to take advantage of a rising market while hedging against any unforeseen drop in the stock price. Although you are continually buying at a higher price, you are managing the downside risk that is an implicit part of all investments. Here is an example.
|Average Price Paid||14|
In this scenario, you purchased a stock for $10 in 2010, and over a five-year period until 2014, the stock rises to a market price of $18. If you had invested all your money in a lump sum, you would have paid an average purchase price of $10 and made a good return with the 2014 $18 stock price.
However, because you invest at intervals and not a lump sum, your average purchase price is $14. You might now be pondering, “Well, if I could have gotten it cheaper, why didn’t I just invest a lump sum. I could profit handsomely!” That answer lies in the next section: the benefits of averaging down.
When averaging down, you take advantage of downward momentum in the stock market by continually investing or drip-feeding money at regular intervals. This allows you to take advantage of downward momentum by continually buying stocks as the price falls while hedging against any rise in the stock price.
Think of it this way: If you buy stock at what you think is the bottom of the stock’s price and it continues to fall, you’ll be kicking yourself. However, by averaging down, you can still hedge against further drops in the stock market, while buying at an average price far below the highest point of stock prices.
|Average Price Paid||6|
In this scenario, the stock was launched in 2010 for the price of $10 per share. However, the price continues to fall to $2 over a five-year period until 2014. The average price you paid for this stock was $6. It wasn’t the $10 that you would have paid at the stock’s height, but it also wasn’t the $2 you paid at its lowest point. In fact, it is right in between.
Remember, by investing the same amount every interval, you’re buying more shares of stock for the same money as the stock’s lower price.
Most investors value stability
Some investors prefer a roulette-like scenario in which you constantly gamble with the ebbs and flows of the market. However, most investors prefer stability over a longer term.
The best way to explain this? Imagine you want to jump into and swim in a cold pool. Now, few of us will know that the pool is relatively cold and proceed to do a cannonball into the water.
Most people will instead dip their toes into the pool, wait, dip their feet in, wait, and then slowly dip the rest of their bodies into the pool until they are fully immersed in water. With averaging up and averaging down, you are slowly immersing yourself in the stock market, toes first.
Can I buy the same stock twice in a day?
Yes, you can buy a stock twice in the same day. If there is a ton of volatility that day, you can average down as the market is falling in the morning and average up as the market is rebounding in the afternoon.
- Averaging up and down in the stock market is a common way for people to invest over a long period of time.
- Both averaging up and down are part of an approach called dollar-cost averaging, which allows investors to take advantage of volatility in the market.
- By averaging up, the investor is taking advantage of the upward momentum in the stock market, while hedging against any unforeseen price drops.
- In contrast, by averaging down the investor is taking advantage of the downward momentum of the stock market by buying for a cheaper price, all while hedging against further dips in the market.
- Most investors prefer a strategy that will maximize returns while heeding risk over a long period of time.
View Article Sources
- Dollar-Cost Averaging — U.S. Securities and Exchange Commission
- Dollar Cost Averaging — Kansas Department of Administration
- What Is Scalping In Trading? Strategies and Examples for Beginners — SuperMoney
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- What is a Stock Float? Examples of High Vs. Low — SuperMoney
- Bullish vs. Bearish Markets — SuperMoney
- What is a Dead Cat Bounce in Stock Investing? — SuperMoney
- What is a Bull Trap in Stock Market Investing? — SuperMoney
- Bear Trap: Stock Market Investing for Beginners — SuperMoney
- Best Online Brokers for Stock Trading in 2022 — SuperMone