INVESTING ESSENTIALS
Consider buying investments at a range of prices at set intervals instead of attempting to perfectly time the markets.
Paying the same value results in buying more shares when prices are low and fewer shares when prices are high.
When markets decline, the last thing many of us want to do is continue investing in them. But rather than being scared by market volatility, take advantage of it with a strategy called dollar cost averaging.
Dollar cost averaging involves making regular investments of a fixed amount over a period of time. Instead of attempting to time the market, you buy in at a range of different prices.
If you contribute regularly to a 401(k) or other retirement account through payroll deductions, you’re already utilizing this strategy.
With dollar cost averaging, you invest a set dollar amount in a fund (typically through broadly diversified mutual funds) on a consistent basis—no matter where the market stands or how great the volatility. This helps eliminate one of the most worrisome aspects of investing: trying to determine the best time to invest.
The beauty of this strategy is that it requires no effort or expertise on your part. Yet despite volatile markets, it may help you improve your long-term returns by buying more shares when the market is down and fewer shares when it’s up.
There are limits, of course. While a dollar cost averaging strategy is helped by a market that is trending upward, it likely won’t improve the performance of an investment that continues to fall in value. (Periodic investment plans do not ensure a profit or protect against a loss in a declining market).
The basis of dollar cost averaging is simple mathematics. When you invest a set amount each month, that static dollar amount buys more shares when the market prices are low and fewer when prices are high.
In a market that is upwardly trending, the shares you bought at below average prices may help tilt your long-term performance slightly higher.
The chart below gives a hypothetical example of how this could happen.
The hypothetical example is for illustrative purposes only.
As you can see, the average fund price by the end of the period was $100, but the average price of the fund shares purchased through dollar cost averaging was only $97.50 ($12,000 ÷ 123.1 total shares). As a result, the investor was able to purchase an additional 3.1 shares. At $100 a share, that’s a positive difference of $310.
To put it another way, if you compared investing the full amount only in January with spreading the investment out over 12 months, the $12,000 investment would have been worth $12,310 at the end of the year—a 2.6% gain attributed entirely to dollar cost averaging (not including interest rate returns in the calculation).
Remember, market and share prices will fluctuate. The key is that you invest on a regular basis and stick with your plan regardless of market fluctuations. Because dollar cost averaging involves continuous investing, investors should consider their long-term ability to continue to make purchases through varying economic conditions.
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