Dollar cost averaging involves investing a set amount of money in the same investment on a periodic basis. Since a fixed amount of money is being invested, more shares are purchased when prices are lower and fewer shares are purchased when prices are higher. Of course, whether dollar cost averaging produces a higher return than investing a lump sum immediately depends on whether the investment's price rises, declines, or fluctuates over the investment period.
While some investors are concerned about how to invest a large sum, many investors use dollar cost averaging as a way to invest over time. For instance, participating in a 401(k) plan is a form of dollar cost averaging, since contributions are taken out of every paycheck and invested in predetermined investments.
For investors who are investing over a long time period, a dollar cost averaging strategy can provide several benefits:
- It requires the discipline to invest consistently, regardless of market fluctuations. Thus, it reinforces the habit of regularly setting money aside for investing.
- It eliminates the need to decide when to invest. With a dollar cost averaging program, you just follow the plan and invest on a periodic basis, without trying to time the market.
- Since your investment is made over a period of time, it keeps you from investing all your money at a market high.
Dollar cost averaging, however, does not ensure a profit or protect against loss in declining markets. Before starting a dollar cost averaging program, you should consider your financial ability to continue purchases through periods of low price levels.
Please call if you'd like to discuss dollar cost averaging and its role in your portfolio.