Dollar-cost averaging – a key to success when investing
Sun Apr 19, 2009 | | Posted in Finances Invest
Dollar-Cost Averaging
Invest the same amount of money every month over an extended period of time, regardless of whether the market is up or down.
Dollar-Cost Averaging has generally two-fold characteristics:
1) You should increase the amount of money you invest as your income increases.
2) You should not make changes because of what the market is doing or what you think it might do.
Furthermore, Dollar-Cost Averaging is:
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Powerful
Even modest monthly investments can grow to substantial amounts due to the power of compounded interest
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Disciplined
It takes the emotion out of investing
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Sound
It avoids the pitfalls of market timing
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Affordable
You can invest small amounts
By investing the same amount each month, you automatically purchase more shares when prices are down and fewer shares when prices are up. In a volatile period, the result of this can be a lower average cost. Hence the term, Dollar-Cost Averaging.
Investing a Lump Sum
So far this year, the average refund is $2705, 11% higher than last year, according to data from the Internal Revenue Service. Instead of dollar-cost averaging, what if you invested a lump sum amount. If you invest it all at once, the market could go down and the value of your investment would drop sharply. This might be more risk than you are comfortable taking.
A good alternative
A good alternative is to divide your lump sum, the average tax refund of $2,705, into equal amounts and invest them over a number of months (6 to 12). This way, if the market drops right away, you have suffered a smaller loss and can buy more shares each month at the lower price. Dollar-Cost Averaging is not without its own risks, however.
- If the market goes up, and stays there, you may regret not investing all at once since you will be buying future shares at a higher price.
- Systematic investing does not assure a profit and does not protect against loss in declining markets.
- Systematic investing involves continuous investment in securities regardless of fluctuating prices. You should consider your financial ability to continue purchases through periods of low price levels.
In a Nutshell
It turns out that you very seldom lose with dollar-cost averaging strategy of investing. Invest the average tax refund so far this year of $2,700 rather than spending it recklessly. Divide the amount into 6 or perhaps 12 equal installments and invest the amount at regular intervals.
And remember, the best way to lose your money is by trying to make money too fast! We all know already what I said above. But we still don’t do it. The best financial strategies in the world go the drain everyday. Very few take advantage and needless to say the ones who do are millionaires and probably billionaires.
It’s always easier said than done. We just make excuses but we could start investing 20 bucks a month and over the years we would see the rewards.
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Information contained herein is general in nature, and is provided for informational and educational purposes only. Past performance is no guarantee of future results. Talk to your financial adviser.
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