What is Dollar-Cost Averaging? | The Motley Fool

Dollar-cost averaging is a strategy that tries to minimize those risks by building your position over time. When you dollar-cost average, you ... 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Follow@louwhiteman Follow@louwhiteman Buyingstockscanbestressful.Buytoosoonandyouriskregretifthepricedrops.Butifyouwaitandthepricegoesup,youfeellikeyoumissedoutonadeal. Dollar-costaveragingisastrategythattriestominimizethoserisksbybuildingyourpositionovertime.Whenyoudollar-costaverage,youinvestequaldollaramountsinasecurityatregularintervals.Ratherthanattemptingtotimethemarket,youbuyinatarangeofdifferentprices. Likewithmostinvestmentstrategies,dollar-costaveragingisnotforeveryone,andtherearetimesitworksbetterthanothers.Butitcanbeapowerfultoolforremovingsomeoftheemotionalbarrierstoinvesting.Here'salookathowdollar-costaveragingworksandthebestwaystousethestrategy. Dollar-costaveragingrequirespatience--itismosteffectiveoverlongperiodsoftime. Whenyoudollar-costaverage,youbreakyourinvestmentintopiecesandputaportionofyourmoneyintothestockmarketatequaltimeintervalsinsteadofputtingallofitintothemarketatonce. Forexample,sayyouhaveidentifiedFoolishCorp.asanattractiveinvestmentandwanttobuy$10,000worthofitsstock.Butyou'venoticedthestockpricetendstomoveupanddownalot,andyouarenotsureifthepriceyou'dpaynowisthebestyou'llseeorifitwilldropinthedaysandweekstocome.Insteadofbuying$10,000worthrightnow,youcouldinsteadbuy$2,000permonthforfivemonths. Thestrategydoesn'thavetobelimitedtoonesecurityorafixedamountoftime.Infact,thosewith401(k)plansandotherretirementaccountsmayalreadybedollar-costaveragingthroughthoseplansbybuyingafixedamountofanumberofmutualfundsandstockseverypaydayregardlessofwhetherthemarketisatanall-timehighorinthemiddleofasell-off. Whydollar-costaveragingworks Dollar-costaveragingworksbecauseitremovessomeoftheemotionalstressthatcomeswithinvesting.Bycommittingtoasetschedule,youdon'thavetoworryaboutwhetherastockisabouttomovehigherorlower. TogobacktotheexampleofFoolishCorp.,let'sassumeyoubuy$2,000worthofitsstockforfiveconsecutivemonths.Let'salsosaythat,onthedaysyoubuy,thestockistradingat$50,$40,$20,$40,and$50,respectively.Overthecourseofthosefivemonths,thestockpriceendedupwhereitstarted,butittookawildrideinthemeantime. Here'showthepurchaseswouldlook: Month InvestmentAmount PriceperShare NumberofSharesPurchased 1 $2,000 $50 40 2 $2,000 $40 50 3 $2,000 $20 100 4 $2,000 $40 50 5 $2,000 $50 40 Total $10,000 $35.71(average) 280 ChartandcalculationsbyMatthewFrankel. Notethatinthisexample,ifyouhadboughttheentire$10,000stakeondayone,youwouldhaveonlygotten200shares.So,bydollar-costaveraging,youwereabletobuymoreshareswithyourmoney.Obviously,that'snotalwaysthecase.Ifthestockpricegoesstraightup,youwouldgetfewershares. Youcanusethisstrategyforanyinvestment,whetherit'sastock,mutualfund,orexchange-tradedfund(ETF).Generallyspeaking,dollar-costaveragingworksbestinbearmarkets andwithsecuritiesthathavedramaticpriceswingsupanddown.Itisthosetimes,andthosetypesofinvestments,wherereducinginvestoranxietyandfearofmissingouttendtobethemostimportant. Ifyoudodollar-costaverage,bewareofhindsight.Itiseasytodoubtyourselfifyouspendtoomuchtimelookingbackward.Ifastockgoesstraightupfromyourstartingpoint,clearlyitwouldhavebeenbettertobuyasmuchaspossibleondayone.Or,takingtheFoolishCorpexample,itwouldhavebeenbettertobuythefull$10,000inmonththree.Butthewholepointofthisstrategyiswehavenowayofknowinghowastockisgoingtomove. Ifyouhaveacrystalball,useit.Butfortherestofus,dollar-costaveragingisabetterstrategythantryingtotimethemarket. When'sthebestdaytodollar-costaverage? Therearealotofso-calledinvestmentexpertswhoclaimtherearecertaindaystodeploymoneyduetopayrollschedulesandmutualfundflows.Don'tbelieveit.Iftherewasamagicalformulaforpickingtherightdayeachmonthtobuystocks,we'dalljustbuythenandnothavetofigureoutotherstrategies. However,whenyoudollar-costaverageisimportant.Specifically,youmustmakeaconsistentplanandsticktoit.Alotofthebenefitofthestrategyisthat,bybreakingtheinvestmentintochunks,youcanavoidworryoverwhentobuyinandavoidtryingtotimethemarket.Therefore,it'simportantthat,onceyoupickadate,yousticktoitnomatterwhathappens. Forexample,sayyoucommittobuy$1,000worthofanindexfundonthefirstdayofeverymonth.But,inmonthfour,younoticethatstockshavebeenupthewholeweekleadinguptothefirstdayofthemonth.Itmightbetemptingtoassumethatasell-offisinevitableanyday,soyouholdoffbuyingonthefirstdayofthemonthinthehopeofgettingabetterpriceinthedaysthatfollow.Ifyoudothat,youeliminatealotoftherationalebehindtryingdollar-costaveraging. What'sthedownsideofdollar-costaveraging? Thereareafewthingstoconsiderbeforedollar-costaveraging.Forone,it'simpossibletopredictwhetherstockpriceswillgoupordownonanyparticularday,week,orevenyear.Butthereisacentury'sworthofdatashowingusthatmarketsdoriseovertime. Ifyouparkmostofyourmoneyoutofthemarketandonlybuyinabitatatime,youavoidshort-termvolatility.Butthatalsomeansaportionofyourcashisonthesidelinesandnotworkingtobuildyournetworth. That'saparticularlybigriskifyouarefocusedondividendstocksandotherincome-generatinginvestments.Exceptinextremecases,dividendpayerscontinuedistributionsingoodmarketsandbad.Ifyouusedollar-costaveragingtoslowlybuildapositioninadividendstock,youmissoutongettingdividendsontheportionofyourcashyouhaven'tyetinvested. Finally,notethatanyinvestmentstrategyisonlyasgoodasthestocksyoupick.Dollar-costaveragingcanhelpeaseapprehensionandisbetterthantryingtotimethemarkets,butitisnosubstituteforfindingqualitycompaniestoinvestin. Isdollar-costaveragingrightforyou? Dollar-costaveragingisbeneficialbecauseitcanreduceinvestoranxiety,helpavoidtryingtotimethemarket,andcanprovideapredictable,regimentedwaytocontinuouslygrowyournestegg.Ifthat'sofinteresttoyou,thereareafewsimplestepstofollow: Decidehowmuchmoneyyouwanttoinvest.Itcouldbeaone-timewindfallyouwanttoputinthemarketoritcouldbeasetamountyouintendtocontributeonaregularscheduleindefinitely. Decidehowoftenyouwanttoinvest.Withtradingcommissionsallbutgone,itcanbedaily,weekly,monthly,oranyintervalyouwant. Decidehowmanyperiodsyouwanttosplittheinvestmentover.Again,itcouldbeafewtimes,oritcouldbethestartofapermanentroutine. Decidethedollaramountinvestedateachinterval.Ifit'salumpsum,dividetheamountbythenumberofperiods.Ifitisanindefiniteinvestmentplan,budgethowmuchyoucanreliablyafford. Stickwiththeplan,nomatterwhatmarketsdoonaparticulardayorweek. Thereisnoonerightwaytoinvest.Butifyou'reaninvestorlookingtoincreaseyournetworthbutworriedyoumightbetemptedtotimethemarket,oryou'rededicatedtoaddingalittlebiteachmonthregardlessofrecentstockreturns,dollar-costaveragingcanbeaneffectivewaytobuildyourportfolio. MoreonInvesting  HowtoInvestaLumpSump Averagestockmarketreturn Howarestockpricesdetermined?  MotleyFoolReturns StockAdvisor S&P500 316% 112% JoinStockAdvisor Discountedoffersareonlyavailabletonewmembers.StockAdvisorwillrenewatthethencurrentlistprice.StockAdvisorlistpriceis$199peryear. StockAdvisorlaunchedinFebruaryof2002.Returnsasof07/04/2022. CalculatedbyTime-WeightedReturn 13StepstoInvestingFoolishly ChangeYourLifeWithOneCalculation TradeWisdomforFoolishness TreatEveryDollarasanInvestment OpenandFundYourAccounts AvoidtheBiggestMistakeInvestorsMake DiscoverGreatBusinesses BuyYourFirstStock CoverYourAssets InvestLiketheMasters WhenshouldIsellastock? 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