Make investing automatic with dollar-cost averaging

Have you ever held off from making an investment because you’re concerned that the timing may not be right? If this fear is preventing you from investing, dollar-cost averaging is an approach that you may want to consider. It has the potential to help you accumulate wealth over time and throughout the market’s highs and lows. Here is an overview of the strategy.

How it works

The concept is simple – you invest a consistent amount of money at regular intervals. You put the money to work in the same investment – a stock, a mutual fund or other type of asset – regardless of the price of the asset. This should continue over an extended period of time.

Investing with such a defined cadence takes market timing out of the picture. If the asset has fallen in price, your periodic investment will allow you to purchase more shares. If the asset rises in price, you’ll purchase fewer shares. If you are committed to your dollar-cost averaging plan, all that matters is maintaining a consistent monthly investment, not the price of the investment you’ve chosen. You may want to periodically increase your monthly contribution amount.

Here’s a brief, practical example of how dollar-cost averaging works. Suppose you commit $200 per month to purchase a mutual fund. In the first month you invest, the share price is $10, resulting in a purchase of 20 shares. In the second month, the price drops to $8, and you purchase 25 shares. In the third month, the value is back to $10, and you again purchase 20 shares. In total, you accumulated 65 shares at an average price of $9.23/share. Yet after three months, your initial $600 investment is worth $650.

While this demonstrates the advantages of dollar-cost averaging during periods of market volatility, keep in mind that the future direction of an investment’s value is difficult to predict. If the share price continues to rise over time, you’ll purchase fewer shares. That means the benefit of the systematic investment approach will be reduced. It’s important to note that dollar-cost averaging does not assure a profit or protect against a loss in declining markets. It is a way to utilize market volatility to your advantage if you invest consistently, hold the investment over the long term and the underlying investment likely increases in value.

You may already be doing it

Dollar-cost averaging may already be part of your investment regimen. If a portion of your paycheck is directed to investments in your workplace retirement plan, you are taking advantage of this strategy by making consistent investments into a specific investment regardless of its value.

Keep in mind the advantages and disadvantages discussed above as you consider whether to use dollar cost averaging. It may also help to consult with a financial advisor to find out more about how this strategy may fit into your financial plan.