How To Invest with Dollar Cost Averaging - Forbes

Dollar cost averaging is a strategy that can help you lower the amount you pay for investments and minimize risk. SelectRegion UnitedStates UnitedKingdom Germany India Youmightbeusinganunsupportedoroutdatedbrowser.TogetthebestpossibleexperiencepleaseusethelatestversionofChrome,Firefox,Safari,orMicrosoftEdgetoviewthiswebsite. advisor Investing AdvertiserDisclosure HowToInvestwithDollarCostAveraging E.Napoletano, BenjaminCurryContributor, EditorUpdated:Feb10,2022,12:08pm EditorialNote:WeearnacommissionfrompartnerlinksonForbesAdvisor.Commissionsdonotaffectoureditors'opinionsorevaluations. GettyImages Dollarcostaveragingisastrategythatcanhelpyoulowertheamountyoupayforinvestmentsandminimizerisk.Insteadofpurchasingsharesatasinglepricepoint,withdollarcostaveragingyoubuyinsmalleramountsatregularintervals,regardlessofprice.Overthelongterm,dollarcostaveragingcanhelploweryourinvestmentcostsandboostyourreturns. WhatIsDollarCostAveraging? Dollarcostaveragingisastrategytomanagepriceriskwhenyou’rebuyingstocks,exchange-tradedfunds(ETFs)ormutualfunds.Insteadofinvestinginaparticularsecurityatonetime,withasinglepurchaseprice,withdollarcostaveragingyoudivideuptheamountofmoneyyou’dliketoinvestandbuysmallquantitiesovertimeatregularintervals.Thisdecreasestheriskthatmightpaytoomuchbeforemarketpricesdrop. Pricesdon’tonlymoveoneway,ofcourse.Butifyoudivideupyourpurchaseandmakemultiplebuys,youmaximizeyourchancesofpayingaloweraveragepriceovertime.Inaddition,dollarcostaveraginghelpsyougetyourmoneytoworkonaconsistentbasis,whichisakeyfactorforlong-terminvestmentgrowth. Ifyouhaveaworkplaceretirementplan,likea401(k),you’reprobablyalreadyusingdollarcostaveragingbydefaultforatleastsomeofyourinvesting. MarketTimingvsDollarCostAveraging Dollarcostaveragingworksbecauseoverthelongterm,assetpricestendtorise.Butassetpricesdonotriseconsistentlyoverthenearterm.Instead,theyruntoshort-termhighsandlowsthatmaynotfollowanypredictablepattern. Manypeoplehaveattemptedtotimethemarketandbuyassetswhentheirpricesappeartobelow.Thissoundseasyenough,intheory.Inpractice,it’salmostimpossible—evenforprofessionalstockpickers—todeterminehowthemarketwillmoveovertheshortterm.Today’slowcouldbearelativelyhighpricenextweek.Andthisweek’shighmightlooklikeafairlylowpriceamonthfromnow. It’sonlyinretrospectthatyoucanidentifywhatfavorablepriceswouldhavebeenforanygivenasset—andbythen,it’stoolatetobuy.Whenyouwaitonthesidelinesandattempttotimeyourassetpurchase,youfrequentlyendupbuyingatapricethat’splateauedaftertheassethasalreadymadebiggains. Andtryingtotimethemarketcanreallycostyou.Accordingtoresearch byCharlesSchwab,investorswhotriedtotimethemarketsawdrasticallylessgainsthanthosewhoregularlyinvestedwithdollarcostaveraging. HowDoesDollarCostAveragingWork? Dollarcostaveragingtakestheemotionoutofinvestingbyhavingyoupurchasethesamesmallamountofanassetregularly.Thismeansyoubuyfewershareswhenpricesarehighandmorewhenpricesarelow. Sayyouplantoinvest$1,200inMutualFundAthisyear.Youhavetwochoices:Youcaninvestallofyourmoneyatonceatthebeginningortheendoftheyear—oryoucaninvest$100eachmonth. Whileitmightnotseemlikechoosingoneapproachortheotherwouldmakemuchofadifference,ifyouspreadoutyourpurchasesin$100monthlyportionsover12months,youmayendupwithmoresharesthanyouwouldifyouboughteverythingatonce.Considerthishypothetical12-monthresult: Month SharePrice NumberofSharesPurchased January $10 10 February $11 9.09 March $12 8.33 April $9 11.11 May $10 10 June $7 14.29 July $9 11.11 August $11 9.09 September $9 11.11 October $10 10 November $9 11.11 December $10 10 Intheexampleabove,youwouldendupsaving42centsasharebyspreadingoutyourinvestmentsover12monthsinsteadofinvestingallofyourmoneyonetime. Ifyoubought$1,200worthofMutualFundAatapriceof$10pershare inJanuaryorDecember,youwouldown120shares. Ifyoubought$100worthofMutualFundAamonthfor12months,youraveragepricepersharewouldbe$9.58,andyouwouldown125.24shares. Inthisexample,dollarcostaveragingbuysyoumoresharesatalowerpricepershare.WhenMutualFundAincreasesinvalueoverthelongterm,you’llbenefitfromowningmoreshares. DollarCostAveragingHelpsThoseWithLesstoInvest Fromapracticalstandpoint,dollarcostaveraginghelpsyoubegininvestingwithsmallamountsofmoney. Youmaynot,forexample,havealargesumtoinvestallatonce.Dollarcostaveraginggetssmalleramountsofyourmoneyintothemarketregularly.Thisway,youdon’thavetowaituntilyouhavealargeramountsaveduptobenefitfrommarketgrowth. Dollarcostaveraging’sregularinvestmentsalsoensureyouinvestevenwhenthemarketisdown.Forsomepeople,maintaininginvestmentsduringmarketdipscanbeintimidating.However,ifyoustopinvestingorwithdrawyourexistinginvestmentsindownmarkets,youriskmissingoutonfuturegrowth. Thosewhoremaininvestedduringbearmarkets,forinstance,historicallyhaveseenbetterreturnsthanthosewhowithdrawtheirmoneyandthentrytotimeamarketreturn,accordingtoCharlesSchwabresearch. DoesDollarCostAveragingReallyWork? Outsideofhypotheticalexamples,dollarcostaveragingdoesn’talwaysplayoutneatly.Infact,researchfromtheFinancialPlanningAssociationandVanguardhasfoundthatovertheverylongterm,dollarcostaveragingcanunderperformlumpsuminvesting.Therefore,ifyoudohavealargesumofmoney,you’regenerallybetteroffinvestingitassoonaspossible. Butdon’ttakethisresearchatfacevalue.Youmaynothavealargeamountofmoneysavedup—andwaitingmaycauseyoutomissoutonpotentialgains.Itcanbestressfultoinvestalotofmoneyatonce,anditmaybeeasierpsychologicallyforyoutoinvestportionsofalargesumovertime. Inaddition,dollarcostaveragingstillhelpsyourmoneygrow.IntheFinancialPlanningAssociation’sandVanguard’sresearch,investorswhouseddollarcostaveragingdidseesignificantinvestmentgrowth—justslightlylessmostofthetimethaniftheyhadinvestedalumpsum. Also,keepinmindthatlumpsuminvestingonlybeatdollarcostaveragingmostofthetime. Athirdofthetime,dollarcostaveragingoutperformedlumpsuminvesting.Becauseit’simpossibletopredictfuturemarketdrops,dollarcostaveragingofferssolidreturnswhilereducingtheriskyouendupinthe33.33%ofcaseswherelumpsuminvestingfalters. WhoShouldUseDollarCostAveraging? Youmightconsiderdollarcostaveragingifyou’re: Beginningtoinvest andonlyhavesmalleramountstobuyshares. Notinterestedinalltheresearchthatgoesalongwithmarkettiming. Makingregularinvestmentseachmonthinretirementaccounts,likeanIRA ora401(k). Unlikelytokeepinvestingindownmarkets. Youmightpreferanotherinvestmentstrategyif: Youhavealargesumtoinvest. You’reinvestinginmutualfunds thathavehigherinitialinvestmentminimumsthroughataxablebrokerageaccount. Youenjoytryingtotimethemarketanddon’tmindtheextratimeandresearch. You’reinvestingfortheshortterm. 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