Have you ever wanted to apply a couple simple rules to your investing practice that have the potential to help preserve your capital? Many people who play the stock market, invest in cryptocurrency, or dabble in forex turn to a pair of guidelines to prevent account balances from dwindling rapidly.
In fact, these two techniques have been around for decades and have been used by some of the world’s top brokerage firms, banks, and institutional investors. In common parlance, the guidelines are called “the two-percent rule” and “dollar-cost averaging (DCA).”
How do they work, and how can everyday investors and part-time traders get the most out of them? Here’s a quick rundown on how virtually anyone can take advantage of these two very simple ways of investing.
The Key To Capital Preservation
In your personal budget, it’s pretty apparent that if you want to save more, you need to do one of two things: spend less or earn a higher income. If you’re like most people, your primary source of income is your salary and perhaps a bit of interest from a savings account.
This same basic principle applies to investing. If you want to preserve your account balance, it’s imperative to “spend less” by calibrating the amount you place on each trade. Both DCA and the two-percent rule achieve this goal, but somewhat differently.
In the end, because they work to build self-discipline into your trading habits, they lead to smaller losses and help preserve your account balance.
Of course, there’s no guarantee that a long series of bad investing decisions won’t drain your account. No rule can protect you from that. Instead, what DCA and the two-percent rule do is help you limit your purchases as you gain experience as a trader.
The main goal is that by the time you have plenty of trades under your belt and better understand how to select winning trades, your account will still have money in it.
The Two-Percent Rule
Note that this rule works in tandem with DCA, although you can use it as a stand-alone trading technique. Simply put, you employ it by never spending more than two percent of your current trading account balance on a given transaction.
For example, if you wish to purchase shares of XYZ Corp. stock at $20 per share, and your account balance is $10,000, you would limit your position on XYZ to 10 shares ($200). You select that limit because 200 is 2 percent of 10,000.
DCA: Dollar-Cost Averaging
DCA is more related to putting money into your account, rather than spending it. Say your annual income is $50,000 and you have been careful about creating a monthly budget. Set aside a line item in your budget for discretionary money that can go to a brokerage account.
If, again as an example, you are able to place $200 per month into your trading account, set it up as an automatic deposit. In this way, you avoid placing uneven sums of money into your account and set a regulated number on how much you can afford to invest. The beauty of DCA is that you won’t run the risk of going broke because the funds are carefully budgeted to begin with.
Putting It All Together
When investors use DCA to build up their available capital and use the two-percent rule to keep the outflow of funds to a reasonable level, their accounts won’t tend to drain down to nothing during those first few months of trading. Note that you can also employ DCA to purchase a set amount of securities each month, which is how many people accumulate precious metals.