Dollar Cost Averaging

Investors often wonder whether they have missed the right opportunity to get into the stock market. If you think the chance has passed you by, dollar cost averaging is the perfect solution.

When investing, you can either invest a lump sum or use dollar cost averageing. With a lump sum, you invest a large amount of money at one time in a stock. However, investing a lump sum requires good market timing. When you use dollar-cost averaging you put a certain amount of money, such as $50 or $100, into an investment on a regular basis regardless of the share price.

Most investors want to buy low and sell high. However, they tend to do the opposite. They usually buy in a rising market and sell in a falling market. Dollar cost averaging will take away the need to time the market.

With dollar cost averaging, your average price per share will be toward the lower side in the long run. It is good for small amounts of money, such as $50 or $100. When you dollar-cost average, you will be able to buy more shares at a lower share price:

In the long run, your cost will be closer to the lower share price because you were able to buy more shares at a lower price and fewer shares at a higher price.

Investors can start dollar-cost averaging with a 401(k) plan or an automatic investing plan (AIP). You can also open a brokerage account to make regular deposits. The AIP automatically deducts a certain amount of money monthly from your checking account. Dollar-cost averaging requires little money to get started, and you are in control of how much money you put into the investment regularly.

Dollar-cost averaging doesn’t work during a rip-roaring bull market, or rising market. However, when’s the last time you predicted a market rise?

Unfortunately, few investments will be volatile enough for dollar-cost averaging to have a huge advantage over a lump sum. For example, the Standard & Poors 500 Index has reported monthly losses 1/3 of the time in the past 35 years. Often, the gains in the preceding month were enough to offset those losses.

On the other hand, dollar-cost averaging works well for volatile sector funds. Research has shown dollar-cost averaging to outperform a lump sum more than 50% of the time. Funds in a single sector change more than broader investments. Another advantage of investing a small amount like $50 a month in mutual funds is that they do not charge commissions for monthly contributions.

If you buy stocks from a broker with this strategy, you will have to pay a commission each time you buy more shares. Those costs will pile up if you are investing money monthly. Luckily, you can buy stocks directly from a company without commissions when applying a DCA strategy. Also, there are Web sites that offer as low as $2 a trade online, which can help minimize the cost of using DCA.

Dollar-cost averaging is another attractive option for investors who have little money to put aside monthly.

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