Dollar Cost Averaging
So, your ready to start investing. You have your high interest debts paid down (or off) and you have your emergency fund setup that can pay for 3-6 months worth of expenses.
Dollar-cost averaging is a simple concept. You invest fixed dollar amounts on a fixed time schedule regardless of price into an investment.
Dollar cost averaging is an investment strategy that aims to reduce the impact of volatility on large purchases of financial assets such as equities.
An example of how it is done:
Let’s say that you set aside $100 per month to invest. The market goes up and down all the time, that $100 will buy less shares when the price is high and more shares when the price is low. Using the dollar cost averaging strategy, you’ll invest that $100 regardless of what the price is so you don’t have to keep up with all the daily fluctuations of the stock market. Your investing plan will be on autopilot and will do that for you. At the end of a year, you will have purchased more shares at the lower price and fewer shares at higher prices.
The alternative plan is to have a lump sum and invest it all at the same time. By doing this you don’t get the advantages cost averaging.
No one can predict what the stock market will do. If the stock market declines throughout the year then you will end up with more shares, but they will be worth less. If the stock market goes up then you will end up with fewer shares, but they will be worth more.
Most experts recommend that if you have a lump sum to invest it as soon as possible to take advantage of the potential returns. This assumes that you have a lump sum to invest.
Dollar cost averaging will allow you to get into the market in a small way without getting killed by an extreme downturn in the market.
If you have a lump sum to invest then you can compare the two plans, but for the average person the dollar cost averaging method allows you to take advantage of a strategy that will hopefully net you great returns over the long run.