Updated: Nov 9, 2021
Everyone would love to buy into the market at a low point, right before it hits an upswing, and then sell for a large profit right at the market’s peak. The trouble is no one is really able to time the market that way – in fact, people who try that often find it’s a quick way to lose money. Attempting to predict which direction the market will go or investing based on feelings can get you in trouble fast. One strategy that can help you avoid all that is dollar-cost averaging.
Dollar-Cost Averaging is a regular, disciplined method for investors to add to their portfolio over time while avoiding emotional decision making.
This can be done for larger investments by dividing up the total amount to be invested to reduce the effect of volatility. Contributions are phased in over the course of time and made on a regular basis regardless of the price of the equity within the account.
This can reduce the risk of investing a large amount in a single investment when the cost per share is inflated. It can also reduce the risk for someone who tends to pull out during a drop in the market, potentially causing a loss in profit.
But you don’t need large sums of money to begin to build your investment portfolio. Dollar cost averaging can serve people new to investing by helping them develop the habit of adding to their portfolio on a regular, ongoing basis.
With dollar cost averaging, you can begin to invest even a small amount of money. Typically, people who follow this approach add the same amount of money either once or twice a month into a particular investment, like mutual funds or ETFs. And they make those contributions on a regular basis regardless of the price of the equity in the account.
Dave Ramsey explains it this way: “If you put in $100 every month or $1,000 every month into your mutual fund, sometimes you’re going to be buying more shares because the mutual fund is cheaper. Other times, you’re going to be buying fewer shares because it’s more expensive. You like it going down because you are buying more shares, and you like it going up because the shares are worth more.”
This strategy can also help you avoid the stress of continuously watching the market to try to buy and sell at just the right time. By dollar cost averaging, you make regular additions to your portfolio whether the market is up or down. When it’s down, the contributions you make purchase more shares. When the market is up, you are buying fewer shares, but those shares are growing in value. It allows investors to put their investment strategy on autopilot.
The term dollar cost averaging implies something done over the long-term. It works best when people stick with it over the course of time. Then the average share price has the potential to be higher than the cost of your average share.
By purchasing shares on a regular, ongoing basis, you have been purchasing fewer shares when the stock was priced high and more shares when the price was low.
Then, after some wild swings, after others panicked and got out only to buy back in after the market began to climb again, you just keep your steady investing with a regular, ongoing amount based on your budget and in keeping with your investment goals.
Dollar-cost averaging does not guarantee profits in rising markets or protect against losses in
declining markets. It is an investment strategy that involves continuous investment in securities regardless of the fluctuating price levels of those securities. Investors should consider their financial ability to continue making purchases through periods of low and high price levels. The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.