Dollar Cost Averaging
Smoothing Out Market Ups And Downs
Systematic investing -- putting away a predetermined amount of money on a regular basis -- is a proven way to pursue the accumulation of wealth over time.
But the strategy, called dollar-cost averaging, produces other benefits as well. By automatically investing the same amount of money every month or quarter over a long period, dollar-cost averaging:-
Encourages discipline. Once you have begun, it serves as a strong reminder to invest at the appointed time.
Eliminates the need to decide when to invest. When it's time to invest, you do so, regardless of what is going on in the market.
Avoids the temptation to time the market. Some investors cannot resist the urge to try to invest at a market low and take their profits at a market high. They usually fail because the task is virtually impossible, even for the experts.
How Dollar-Cost Averaging Works
The object is to invest a set amount of money at regular intervals so the average cost of shares tends to even out the market's peaks and troughs. Your dollars purchase fewer shares when the market is up, but they buy more when it's down. While you may not achieve the positive results of buying at the market's low point and selling at its high point, neither will you suffer the consequences of doing the opposite.
On average, in a generally rising market, you have the opportunity to accumulate wealth over time in a systematic, organized way.
Four things to remember about dollar-cost averaging
In the long run, it doesn't matter when you start, just that you start. Over a long enough period, it makes little difference whether the market was up or down when you began.
Making monthly additions to your account allows you three times as many opportunities to benefit from favorable market swings as investing on a quarterly basis. On the other hand, of course, it provides three times as many chances for your account to be adversely affected by market swings. The more frequently you invest and the longer you keep investing, the smoother the average-share-cost line becomes.
A market decline can mean bargain prices. Unless you are selling shares, a fund's price quote in the daily paper is not relevant for anyone who is not planning to sell, so don't panic if it is down. In fact, a downturn provides the opportunity to buy more shares at attractive prices -- shares that have the potential to grow in value when the market finally turns upward.
Be prepared to weather a sustained market decline. Keep in mind that in order for dollar-cost averaging to work, you must be prepared to commit the financial resources and have the resolve to make the contributions on each appointed date.
Regular investing does not ensure a profit and does not protect against loss in declining markets. Investors should consider their ability to invest continuously during periods of fluctuating price levels.
Let's say you'd like to invest $2,000 in a mutual fund.
Using dollar-cost averaging, you could plan to make five monthly payments of $400 each, buying shares at both highs and lows.
You might start buying some shares at $10 each, and later buy some shares for as little as $5 each. The average cost would be $7.69.
But if you had invested all of your money at the beginning, your average share price would be $10.
And by putting money in a little at a time, you don't have to worry about trying to figure out if the market is going up or down.
