Sound familiar? If you’ve ever agonized over when you should invest, you may have come to realize it is hard for an individual investor to try to time the markets. Another strategy? Dollar cost averaging.
Consistency vs. timing
It sounds technical, but dollar cost averaging is quite simple: you invest a consistent amount, week after week, month after month (think payroll contributions going into your 401(k) account) regardless of whether the markets are up, down, or sideways. No guesswork and no timing necessary.
Autopilot investing at work.
Let’s assume you invest $100 a month into a mutual fund. The fund’s share price changes from month to month so the number of shares your money can buy also goes up and down each month.
At the end of six months, you’ve invested $600 and own 61 shares.1 The average share price over those six months was $10.33, however you paid less – only $9.83 per share because you were able to buy more shares each time the share price went down.
For illustrative purposes only.
If you had invested that same $600 all at once in month one, you would have gotten only 50 shares (at $12 a share) for your money. Of course, if you had invested your $600 in month five when the share price was down to $8, you’d own 75 shares. But no one can accurately pick when that low point will happen with every investment they own every time. Even the experts don’t have a crystal ball. That’s why dollar cost averaging is preferred by so many investors. You invest the same dollar amount each month and let the law of averages take over.
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Dollar cost averaging cannot guarantee a profit or prevent losses in declining and volatile markets. Investors should consider their financial ability to continue their purchases through periods of low-price levels.
1 Shares purchased have been rounded to the next whole share.
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