The Benefits of Dollar-Cost Averaging

You may have heard it said that successful investing is all about timing - knowing when to get into the market and when to get out. Truth is, it's nearly impossible to correctly "time the market." Successful investing is about "time in," not "timing," the market.

"Buy low, sell high" may seem like good advice, but even experienced investors find it impossible to pinpoint with any degree of accuracy when the market will go up or down. That's why putting a fixed amount of money into an investment on a regular schedule, regardless of market conditions, is widely recognized as a sound investment strategy. This simple, long-term strategy of regular investing is known as dollar-cost averaging.

Dollar-cost averaging has been described as one of the most time-tested ways to invest. Through dollar-cost averaging, the amount you invest is always the same. That means you end up buying more shares when the price is low and fewer shares when the price is high.

Your natural instinct might be to stop investing if the price starts to drop - but history suggests that may be the best time to invest. Think about it. When is the best time to buy? When you are getting good value. Dollar-cost averaging can be an especially effective strategy for funds or stocks with sharp ups and downs, since it gives you more opportunities to purchase shares less expensively.

Of course, while dollar-cost averaging has the potential to reduce the average cost of a share of stock or a mutual fund, it does not guarantee a profit or protect against loss in declining markets. Also, since such a plan involves continuous investment in securities regardless of fluctuating prices, you should choose an amount you feel comfortable investing under all market conditions.

An Example of Dollar-Cost Averaging

Let's say, for example, that you put $100 a month into the same investment for six months. The share price is up in some months, down in other months. The table below shows how you might have done.

Month

Investment

Share Price

Number
of Shares Bought

January

$100

$10

10.00

February

$100

$8

12.50

March

$100

$5

20.00

April

$100

$10

10.00

May

$100

$16

6.25

June

$100

$10

10.00

Total:

$600

68.75

Results:

Average Share Price:

$9.83

($59/6 months)

Average Share Cost:

$8.73

($600/68.75 shares)

Current Share Price:

$10.00

Current Value of Investment:

$687.50

In this example, the average share price over the period was $9.83, but the average cost to you was $8.73.

Lump Sums

Dollar-cost averaging is a sensible strategy when you're investing gradually over time toward a long-term goal, such as retirement or a child's education. But what if you find yourself with a large lump sum to invest - for example, a retirement plan distribution, the proceeds from the sale of a business, or an inheritance? In the case of a lump sum, many experts believe that you should put all the money to work for you immediately, rather than invest it in increments over a period of time. By investing it all as soon as possible, you put the power of compounding to work at once (see Investing for Success: The Importance of Starting Early).

For most investors, lump sums don't come along very often. In the meantime, dollar-cost averaging is a consistent approach that takes the emotion out of investing. If you can stick to the plan, it helps you to develop mental toughness during down markets and to avoid overbuying during up markets. And it's easy to use - you can arrange to do it through automatic investment services available from most stock brokerages and mutual funds.