Dollar Cost Averaging
When it comes to the stock market, time is more important than timing.
Because the market is unpredictable, investing is a challenge for even the most informed investors. That’s why investing on a regular basis over a period of time may be better than trying to pick the right time to jump into the market.
This process is called dollar cost averaging, and it may help you overcome the uncertainties of the market by investing more strategically.
How dollar cost averaging works
When you invest the same amount regularly, you end up buying fewer units when the market is up and more units when the market is down. This may cut your average cost per share because you're buying fewer units at a higher price and more units at a lower price.
Here's an example of how dollar cost averaging might work over a six-month period (actual results will vary):
|Amount Invested||Unit Price||Shares Bought|
Average Unit Price: $59 / 6 months= $9.83
Average Price Paid: $1,200 / 124.29= $9.65
With dollar cost averaging you tend to worry less about market fluctuations and whether you chose the right time to invest. And if you use a dollar cost averaging strategy throughout your period of investing, you may be able to reduce volatility in your portfolio by as much as 40%.1
Another advantage is that you end up buying more units when prices are lower. A dollar cost averaging strategy involves continuous investment, regardless of the investment’s fluctuating prices. Be sure to consider your financial ability to continue purchases through periods of low price levels.
If you're enrolled in your employer-sponsored plan, like a 401(k), 457 or 403(b) plan, you're actually practicing dollar cost averaging. You're making contributions in consistent amounts, and you're able to take advantage of regular investing through payroll deductions.
Other things to consider
Although dollar cost averaging is a good method for long-term investing without having to navigate market fluctuations, you aren't guaranteed a profit or protected from loss in a declining market. Dollar cost averaging helps you avoid investing too much when the market is high and too little when the market is low.
For more information about dollar cost averaging and how to make your money work better for you, contact your investment professional. Don’t have an investment professional? Learn why to work with one and how to choose one.
1Lifetime Dollar-Cost Averaging: Forget Cost Savings, Think Risk Reduction, Journal of Financial Planning, 2005. (downloaded 7/31/07).