Investors do not put their cash and other resources in investments without the expectation of profit. In the case of investment instruments such as stock shares, this profit can potentially be realized when the price of the stock shares rises. If the price increases, the investor can sell off the instrument and pocket the difference between the purchase price and the selling price as profit. Both dollar cost averaging and buying and holding are examples of investing strategies. Dollar cost averaging is more flexible and more suited to the short term, while buying and holding is easier to implement and better suited to the long term.
Dollar Cost Averaging
Dollar cost averaging is an investment strategy whereby the investor spends the same sum of money at regular intervals to purchase one specific investment instrument. For example, an investor spends $2,000 each year to purchase shares in a specific corporation, regardless of the current share price. Since this method means more shares are purchased when the share price is low and fewer shares are purchased when the share price is high, the average share price falls as time passes and more and more shares are accumulated by the investor.
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Buying and Holding
Buying and holding is an investment strategy whereby the investor purchases an investment instrument and then holds onto it in order to profit as the instrument's price increases as time passes. For example, an investor purchases 10 shares at $10 each and holds onto them for 10 years; assuming an average annual growth of 10 percent, that $100 becomes $259.37 at the end of those 10 years. Buying and holding's advantages are that the investor incurs no transaction costs and that the stock market's normal long-term trend is upward.
Short Term
Dollar cost averaging serves you better in the short term because it is more flexible and more useful under economic conditions that run against the general upward market trend. An investor using dollar cost averaging can react to economic recessions by selling off the investment in order to stem the losses. However, this isn't always desirable, because market trends rise in the long term, and selling off investments early prevents an investor from benefiting from the rise. Furthermore, dollar cost averaging is more difficult than buying and holding to implement, and it requires more investment of time and effort from the investor. Its flexibility also admits the possibility of investor error.
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Long Term
Buying and holding is suited to long-term investing because the normal market trend is upward. Although individual investors who actively buy and sell in the market can beat the return on the stock market as a whole, it is rare for them to do so consistently without specialized knowledge of finance and an enormous investiture of time and effort researching investments and looking for good opportunities. In most cases, it is simpler and less risky for an investor with a long-term perspective to build a portfolio based on a stock index and hold onto that portfolio in order to benefit from the increase in its value as time passes.
