Dollar-cost averaging is a fancy word for regularly investing a fixed dollar amount, regardless of the share price. In doing so, the total price paid is less affected by market timing. Instead, get into the ritual of developing a disciplined investing habit, be more efficient in how you invest, and lower your stress level and costs.
Even if you start small with $50-$100 per paycheck, set up an automatic transfer to your investing account and repeatedly buy low-cost index funds. It is essential to set it up automatically so you don’t forget or get into decision fatigue. Set it up and forget about it. Your wealth will begin to build over time.
Dollar-cost averaging can occur inside your 401K, IRA, or taxable brokerage account. Pro-tip: have your dividends reinvested automatically to take advantage of extra dollar-cost averaging.
Any investor can use dollar-cost averaging’s investment strategy to take advantage of its benefits, which include a potentially lower average cost, automatic investing over regular intervals of time, and a method that relieves them of the stress of having to make purchase decisions under pressure when the market is volatile.
Dollar-cost averaging may be especially useful to beginning investors who lack the experience or expertise to judge the most opportune times to buy.
It’s worth noting that using dollar-cost averaging means purchasing when the market is high and low. The strategy cannot protect investors against the risk of declining market prices. Like the outlook of many long-term investors, it assumes that prices, though they may drop at times, will ultimately rise.
If you’re investing in single stocks (which I don’t recommend), this may not be the best strategy for you because a company may have several factors that could result in the individual stock tanking.
Here is an example from Bankrate.com of dollar-cost averaging:
Imagine an employee who earns $3,000 each month and contributes 10 percent of that to their 401(k) plan, choosing to invest in an S&P 500 index fund. Because the fund’s price moves around, the number of shares purchased isn’t always the same, but $300 is invested each month. The table below shows this example over ten months.
| Month | Contribution | Price of fund | Shares bought | Shares held | Total value |
|---|---|---|---|---|---|
| 1 | $300.00 | $100.00 | 3 | 3 | $300.00 |
| 2 | $300.00 | $97.50 | 3.08 | 6.08 | $592.80 |
| 3 | $300.00 | $101.30 | 2.96 | 9.04 | $915.75 |
| 4 | $300.00 | $85.45 | 3.51 | 12.55 | $1,072.40 |
| 5 | $300.00 | $91.23 | 3.29 | 15.84 | $1,445.08 |
| 6 | $300.00 | $93.20 | 3.22 | 19.06 | $1,776.39 |
| 7 | $300.00 | $96.50 | 3.11 | 22.17 | $2,139.41 |
| 8 | $300.00 | $100.54 | 2.98 | 25.15 | $2,528.58 |
| 9 | $300.00 | $101.43 | 2.96 | 28.11 | $2,851.20 |
| 10 | $300.00 | $105.00 | 2.86 | 30.97 | $3,251.85 |
The value of the employee’s investments went up 8.4 percent on their $3,000 in total contributions, despite the fund only increasing 5 percent over the period. The employee could buy more shares when the price was lower, taking advantage of the market volatility.
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