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.
What is dollar cost averaging?
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.
Here's an example of how dollar cost averaging might work over a six-month period (actual results will vary).
In this dollar cost averaging example, the average price per share over six months is $9.83 ($59 total share price divided by six months). But because of dollar cost averaging, the price paid for each share was only $9.65 ($1,200 total amount invested divided by total number of shares bought).
The advantages of dollar cost averaging
With dollar cost averaging, you tend to worry less about market fluctuations and whether you chose the right time to invest. If you use this strategy throughout your period of investing, you may be able to reduce the volatility in your portfolio.
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 regular contributions in consistent amounts, 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.