Economy & Jobs
Why Dollar-Cost Averaging Should Be Part of Your Investing Strategy
Investing is one of the best ways to grow wealth over time and to protect your money from inflation. Unfortunately, many people assume it requires specialized knowledge, a large sum of money, or both.
In reality, you don’t need sophisticated skills or large upfront costs. You can start by employing a simple, easy-to-use strategy called dollar-cost averaging (DCA).
Here’s how it works: First, decide on a specific amount to invest regularly, which could be as little as $10 per month. Keep in mind, though, that the more you invest, the more your portfolio balance can grow.
Next, set up an automated investing plan that invests this money into the market at regular intervals. For example, your plan might pull $50 from your bank account every month and invest it in a mutual or index fund.
This is where dollar-cost averaging comes into play. You designate a particular fund or stock that you’d like to invest in each month. During months when the market is high, your $50 investment will automatically buy fewer shares. When the market is low, your same $50 will buy more shares.
Buy Low, Sell High
Say you decide to invest $100 per month in an index fund that tracks the Dow Jones. In January, this fund costs $30 per share, so your investment purchases 3.3 shares. In February, the fund trades for $50 per share; your money buys two shares. In March, the fund drops to trading for $20 per share. Your investment picks up five shares.
The premise behind DCA is simple: Successful investing comes from buying low and selling high. Many people have a tough time doing this, because it’s natural to react to market lows with fear and to highs with exuberance. DCA removes this element of emotion from your investing decisions by systematically and automatically buying more shares when the market is low and fewer when the market is high.
No one knows in the moment when the market has reached bottom or top, and that’s OK. DCA allows you to capture multiple price points as the market moves. Using this method, your investing will most likely perform on average, mimicking the overall market, which, historically, has risen at about 7 percent over a long-term annualized average.
DCA’s secondary benefit is that because it forces you to set up an automated investing plan, you’ll invest at regular intervals—something you might not remember to do otherwise. Better finances with very little effort? Yes, please.