What is dollar-cost averaging?


investing 401 kimage credit: Good Search

What is dollar-cost averaging? Are you someone who wants to invest money, but doesn’t make a move until you’re “too late”—so, you don’t invest at all? If so, then maybe dollar-cost averaging is for you. It’s one option to get you saving.

Let’s say you have $5,000 available for investing. You could either invest it all one time and let it be, or, you could ease into the market over time in equal installments at regular intervals (every month, or every quarter.) The index price may move from $100 to $75 to $55 to $75 to $100. Let’s say you buy at $1,000 installments. You’ll buy more shares when the price is low, and fewer shares when the price is higher. You’ll have an average-cost per share $81. If you put the entire $5,000 in at one time, your average-cost per share is $100.

History favors putting in a lump sum of money because over the (very) long haul, markets have gone up.

However, with dollar-cost averaging, which is basically what you’re doing if you have a 401(k), or other employer sponsored retirement plan, if you put some of the money in at the wrong time, you’re bound to put some of the money in at the right time. If you put a lump sum in at the wrong time—it’s gone. With dollar-cost averaging, you’re buying stocks when they’re low. That goes against everything our emotions tell us to do. Buy more when prices are low, and buy less when prices go up. The advice, “Buy low, sell high” is fine until we’re sitting in the driver seat.

During the strongest markets, dollar-cost averaging came up short with 19.2 percent less wealth than lump-sum investing. During average or weak markets, dollar-cost averaging will cost you 3.6 percent of your holdings. However, the strategy of dollar-cost averaging may help you sleep at night rather than fearing you’ve dumped $5000 into a black hole. It minimizes regret.

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