Buying shares of companies at a lower price than you would otherwise can result in greater returns when you decide to sell these assets later on. While the financial markets are in a constant state of flux, over long periods of time, most stocks tend to move in the same general direction, swept along by larger currents in the economy. You might consider using the dollar-cost averaging strategy to invest in an exchange-traded fund or no-load mutual fund. Over time, the average cost per share you spend should compare quite favorably with the price you would have paid if you had tried to time it. From a practical standpoint, dollar cost averaging helps you begin investing with small amounts of money.
Here’s what dollar-cost averaging is and how to use it to maximize your investment gains. You could be utilizing dollar-cost averaging already and not even be aware of it. For instance, a common example of dollar-cost averaging is an employee who invests regularly in their 401(k). Regardless of the amount you have to invest, dollar-cost averaging is a long-term strategy. Dollar-cost averaging is a less risky way to obtain a favorable price per share. If you have a 401(k) retirement plan, you’re already using this strategy.
When the market moves higher, your regular contribution will buy fewer shares, but you’ll already have shares from prior purchases, so you’ll still gain and won’t completely miss out. With dollar-cost averaging, you’ll be buying over time and averaging your purchase prices. “The main disadvantage is that when the market is up the share price of the investments you’re purchasing are likely to go up as well which means you’re buying at a premium,” says LaFleur. Still, the availability of no-load mutual funds, which by definition do not charge transaction fees, combined with their low minimum investment requirements, offers access to investing to almost everyone.
For some people, maintaining investments during market dips can be intimidating. However, if you stop investing or withdraw your existing investments in down markets, you risk missing out on future growth. When investors purchase securities over time at regular intervals, they decrease the risk of paying too much before market prices drop. So sometimes investors use dollar-cost averaging to help navigate the bumpy times.
But if you divide up your purchase and make multiple buys, you maximize your chances of paying a lower average price over time. In addition, dollar cost averaging helps you get your money to work on a consistent basis, which is a key factor for long-term investment growth. This strategy is best for new investors with limited capital and market knowledge and people with a long-term investment horizon.
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Joe bought different share amounts as the index fund increased and decreased in value due to market fluctuations. In either case, you’ll need to note the ticker symbol for the security; that’s the short-hand code for the stock or fund. The offers that appear on this site are from companies that compensate us. But this compensation does not influence the information we publish, or the reviews that you see on this site.
How to Invest Using Dollar-Cost Averaging
Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
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Using dollar-cost averaging, your cost-per-share may even out and be lower, but you may also get weaker returns. Through lump-sum investing, you may pay more per share but expose your money to the market which can lead to higher returns but also more risk. In this way, dollar-cost averaging may be a safer bet for people with a low risk tolerance. Dollar cost averaging’s regular investments also ensure you invest even when the market is down.
You may think you need thousands of dollars to get started with investing, but you don’t. While a lump-sum investor may use that strategy, using dollar-cost averaging, you can invest a smaller amount in regular intervals to build wealth over time. Another major draw of dollar-cost averaging is that it can reduce the average price you pay for the assets you purchase. The example used earlier in this article is a good way to illustrate this potential benefit. In this case, if you were to sell in the month four at $20 share price, you’d sell your 15 shares for $300, effectively breaking even and not making a profit. If you were to sell in month 4 at a $40 share price, you’d sell your 15 shares for $600, making a profit of $300.
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Indeed, dollar-cost averaging helps lessen potential losses in bear markets, but it also might limit your potential gains in bull markets. You benefit from modest gains over long periods when assets increase steadily. It can help you reach your financial goals at a consistent and manageable pace. Dollar-cost averaging is an effective way to build a portfolio since it involves continuous investments over time. It allows investors to adjust their contributions according to available funds and can be customized around any budget. Dollar-cost averaging provides less stress because you are not investing your entire savings at once.
- Every two weeks 10%, or $100, of Joe’s pre-tax pay will buy $50 worth of each of these two funds regardless of the fund’s price.
- With regard to actually using the strategy, how often you use it may depend on your investment horizon, outlook on the market, and experience with investing.
- Even if it’s not a lot at first, the most important point is to begin investing regularly.
- Through lump-sum investing, you may pay more per share but expose your money to the market which can lead to higher returns but also more risk.
- Dollar-cost averaging requires investors to buy multiple times, which could mean higher accumulated transaction costs.
- Be sure to research fees and costs as part of your investment planning.
All of our content is based on objective analysis, and the opinions are our own. This article will give you the information you need to answer that question, reviewing the benefits of this particular strategy and assessing the alternative. The Fidelity Youth® Account gives teens the power to save and invest their money. Our goal is to deliver the most understandable and expenses and benefits: loans offered to workers comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos. Below are discussed further the pros and cons of dollar cost averaging.
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So starting with your monthly budget, figure how much you can devote to investing. Once you have an emergency fund in place, how much can you invest and not need? Even if it’s not a lot at first, the most important point is to begin investing regularly. Now see if your broker will allow you to set up an automatic purchase plan for that investment. Regardless of what amount and frequency you select, the important part is to stick with it. That way, you can benefit from the strategy of dollar-cost averaging by buying your underlying asset when it rises in value and also when it declines.
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Every two weeks 10%, or $100, of Joe’s pre-tax pay will buy $50 worth of each of these two funds regardless of the fund’s price. Using this strategy to buy an individual stock without researching a company’s details could prove detrimental, as well. That’s because an investor might continue to buy more stock when they otherwise would stop buying or exit the position.
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