Investing 101: Dollar-Cost Averaging Explained

If you want to build wealth over time or have some extra funds to fall back on for emergencies (or fun), one of the best things you can do is to start investing. Unfortunately, many people refrain from investing in the stock market because they think it requires a great deal of money to get started. For those who have the patience may see their money grow over time, with the help of dollar-cost averaging.

Modern investing is set up so that nearly anyone can get started; thanks to some old fashion strategies and new technology. Anyone can start investing with just a little money — less than $100 to start up an account. However, we need more than money to begin investing, we need knowledge and direction.

With some self-education and expert advice from a trusted broker or financial advisor, anyone can make smart investing moves; dollar-cost averaging may be the technique to help you avoid putting too many dollars into one baskets and risk losing it all.

Dollar-cost averaging is an investing technique when combined with asset allocation, it’s a nearly unstoppable force that can grow your wealth far beyond what you ever imagined. This guide to dollar cost averaging for new investors was created to explain why this technique works and how you can implement it into your own portfolio.

What is Dollar-Cost Averaging?

Dollar-cost averaging is a simple investment strategy that can lower your risk, increase your profits, make market volatility less stressful, and help strengthen your financial safety net.

Instead of investing your money in a lump sum, the investor buys smaller amounts of an investment vehicle over a longer period of time. For instance, you could enroll in a direct stock purchase plan or dividend reinvestment plan and have $100 withdrawn every week from your checking account to invest in shares of stock.

The idea is that by setting aside a fixed sum to buy, regardless of the share price, you end up buying more shares when the price is low and fewer when the price is high. This spreads the cost out over several years, providing insulation against changes in market price. Eventually, the average cost per share will become smaller and smaller.

Why Is the Dollar-Cost Average So Important?

The theory behind dollar-cost averaging is that it removes emotion from the investing process and allows you to buy shares at a lower price without having to spend all of your (valuable) time trying to time the market. The technique designed to reduce market risk, save a lot of time, effort and money.

a dollar cost averaging plan, look at concrete examples of how it can lower an investor’s cost basis, and discover how it reduces risk.

How Dollar-Cost Averaging Works:

For example, you decide to dedicate a $100 lump-sum to purchase stock in a company each month for three months. In January, the stock is worth $50, so you buy two shares. In February it is dropped to $33, so you buy three additional shares. Finally, in March, you buy five shares at $20. In total, you purchased 10 shares for an average price of approximately $34 each.

Begin a Dollar-Cost Averaging Plan

Before you implement a dollar-cost average strategy into your investment plans, you will want to consider the following 3 steps:

  1. Decide how much money you can invest each month. Ensure you are financially capable of keeping the amount consistent; otherwise the plan will not be as effective.
  2. Select an investment vehicle that you want to hold for the long-term (5 to 10 years or longer).
  • Invest that money, into the vehicle you have chosen, at regular intervals (weekly, monthly or quarterly works best). If it is possible, set up a plan to automatically deduct the lump-sum from your paycheck or account.

Combining the Power of Dollar Cost Averaging with Diversification and Other Investment Strategies

Index funds are passively managed mutual funds designed to mimic the returns of certain financial indices (S&P 500, Dow Jones, etc.). An index fund investor owns a fractional interest in every one of the stocks that make up that index — like built in diversification tool that prevents you from placing too much stake in any one company — for a fraction of the cost in management fees.

The dollar cost averaging component reduces market risk, while the index fund investment reduces the risk of holding too many positions in one company. This combination can be among the best investment options for individuals looking to build up their wealth over time, without having to manage the investment on a day to day basis.

Speak with your trusted financial advisor, investment broker or mutual fund manager to see if a dollar-cost average plan will support your specific financial situation and investment goals.

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