Three Potential Benefits of Dollar-Cost Averaging

Dollar-cost averaging is an investment strategy that many people use without even realizing it. If you invest through an employer-sponsored retirement plan, such as a 401(k) plan, chances are you are already using this strategy.

With dollar-cost averaging, you invest the same dollar amount at regular intervals. If you deduct a set amount from your paycheck each pay period and invest it in your retirement savings plan, that’s dollar-cost averaging.

3 Potential Benefits Of Dollar-Cost Averaging

1. Dollar-cost averaging is convenient — it puts investing on auto-pilot. And that can be a smart way to build assets for your future.
2. With dollar-cost averaging, you don’t have to worry about the best times to buy and sell, a concept known as “market timing.” Even the most seasoned professional investors have trouble timing the market.
3. Dollar-cost averaging can help you take advantage of unexpected swings in the market.

Let’s take a look at how dollar-cost averaging works

Because you’re investing the same dollar amount each time you invest, you buy more investment shares when prices are low, and fewer when prices are high. Over time – especially the long term — this has the potential to result in a buying advantage. Let’s look at a simple, hypothetical example.

Let’s say you invest $100 per month for six months in mutual fund A. The price of "mutual fund A" bounces up and down each month. At the end of that six-month period, you have invested $600 and own 32.2 shares of mutual fund A.

If you divide the total amount invested by the number of shares you own, your average cost is $18.63 per share. However, if you add up the changing prices over the six-month period and divide by six, the average price could be lower or higher than the average cost. So there is a possibility that the average cost and average share price can vary.

Which Is Right For You?

In the end, deciding between lump-sum investing and dollar-cost averaging illustrates the classic risk-reward tradeoff that all investments entail. Even if you're convinced a lump-sum investment might produce a higher net return over time, are you comfortable with the uncertainty and level of risk involved? Or are you increasing the odds that you won't be able to handle short-term losses — especially if they occur shortly after you invest your lump-sum — and sell at the wrong time? It's important to know yourself and your limitations as an investor. Understanding the pros and cons of each approach can help you make the decision that best suits your personality and circumstances.

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