How to Invest Using Dollar-Cost Averaging
Dollar-cost averaging is particularly attractive to new investors just starting out. It's a way to slowly but surely build wealth even if you're starting out with a small stake.
As many experts will tell you, nobody can time the market. Dollar-cost averaging is a simple technique that entails investing a fixed amount of money in the same fund or stock at regular intervals over a long period of time eliminating the need to market time.
How do I Invest Using Dollar-Cost Averaging?
The strategy couldn't be simpler. Invest the same amount of money in the same stock or mutual fund at regular intervals, say monthly. Ignore the fluctuations in the price of your investment. Whether it's up or down, you're putting the same amount of money into it.
The number of shares purchased each month will vary depending on the share price of the investment at the time of the purchase. When the share value rises, your money will buy fewer shares per dollar invested. When the share price is down, your money will get you more shares.
Over time, the average cost per share you spend will probably compare quite favorably with the price you would have paid if you had tried to time it.
What are the rewards of Dollar-Cost Averaging?
In the long run, this is a highly strategic way to invest. It is a strategy that almost certainly will get results that are as good or better than aiming to buy low and sell high.
As you buy more shares when the cost is low, you reduce your average cost per share over time. Dollar-cost averaging is particularly attractive to new investors just starting out. It's a way to slowly but surely build wealth even if you're starting out with a small stake.
Here is an example of how dollar cost averaging works:
Assume an investor deposits $1,000 on the first of each month into Mutual Fund XYZ, beginning in January.
Like any investment, this fund bounces around in price from month to month. In January, Mutual Fund XYZ was at $20 per share. By Feb. 1 it was at $16, by March 1 it was $12, by April 1 it was $17, and by May 1 it was $23.
The investor keeps steadily putting $1,000 into the fund on the first of each month while the number of shares that amount of money buys varies. In January, $1,000 bought 50 shares. In February, it bought 62.5 shares, in March it bought 83.3 shares, in April it was 58.2 shares, and in May it was 43.48 shares.
Just five months after beginning to contribute to the fund, the investor owns 298.14 shares of the ETF. The investment of $5,000 has turned into $6.857.11. The average price of those shares is $16.77. Based on the current price of the shares, the investment of $5,000 has turned into $6,857.11.
If the investor had spent the entire $5,000 at once at any time during this period, the total profit might be higher or lower. But by staggering the purchases, the risk of the investment has been greatly reduced. Dollar-cost averaging is a safer strategy to obtain an average price per share that is favorable overall.
If you have a 401(k) retirement plan, you are applying this strategy already.