Why Should I Dollar Cost Average My Investments?
by Dave Mauder
Dollar cost averaging is a common term that gets tossed around a lot in the investment arena. But do we really know what it is and why we should utilize it?
Dollar cost averaging means you invest a fixed amount of money into a particular stock or mutual fund on a regular basis, usually weekly, monthly or quarterly. By investing the same amount regularly, you automatically buy more shares when the price is down, and fewer shares when the price goes up.
This is a very important strategy to understand and use, especially during shaky market conditions and uncertain economic times.
Lets say you invest $100 into a stock mutual fund on the first day of each month. If the price per share is $10 on the first of the month, you get 10 shares for your $100. If the fund price moves up to $12 per share, your $100 will buy only 8.33 shares. But if the fund price moves down to $8 per share, your $100 will buy 12.5 shares.
Over time, usually a period of a few years, dollar cost averaging allows your average price per share to be considerably lower than the current actual cost per share of the investment. In the example above, you would now have 30.83 shares of the mutual fund, for which you invested $300 out of your pocket. Your average price per share is $9.73. With this investment strategy, time is your best friend.
Dollar cost averaging does not guarantee protection from a declining stock market, nor does it guarantee a profit. What it DOES do is develop a great habit of saving money.
A systematic method of investing money will ALWAYS win over a plan based on your will power. Most mutual fund companies and brokerage firms offer automatic investment plans that will dip money right out of your checking account in the amount and frequency that you determine.
My wife and I have been dollar cost averaging our investments since about 1990. We have money automatically deposited each month into our IRA’s, joint mutual fund account, and college funds for our children.
If we didn’t set up this automatic investment plan, there would probably be very little money in any of our accounts! Of course, a 401(k) plan (if your employer offers one) also provides a great way to dollar cost average your investments, with a great tax benefit to boot!
At this point, you might be asking yourself when is a good time to start investing with this strategy. What about this crazy roller-coaster stock market? Should you be worried? Not one bit!
In fact, if you choose to dollar cost average, now is a perfect time to start investing. Why? Because you can purchase many more shares for the same money. When the market does finally recover, your average cost per share should be quite low.
So now that you know what dollar cost averaging is, and how powerful it can be as a long-term investment plan, why not get started today while stock and mutual fund prices are fairly low. Take advantage of the market conditions and put time on your side.
Happy Investing!
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