Investors usually want to reduce their market risk and eliminate some of the guesswork of deciding when to invest. One way of doing this is dollar cost averaging, according to Pat Swanson, CFP® and families specialist with Iowa State University (ISU) Extension’s Invest Wisely Project (www.extension.iastate.edu/investwisely).
“Instead of waiting to invest a single lump sum when you feel prices are at a low, with this strategy you consistently invest smaller amounts over a longer period of time – for example $100 every month,” Swanson explains.
“When prices are low, more shares are purchased and when prices are high, fewer shares are purchased. While you may hesitate to buy more shares when the market is going down, dollar cost averaging works best in this type of market. Over time the average cost per share of the security may become less. This way you can accomplish the ‘buy low, sell high’ goal of successful investing.”
The starting point is to decide how much you can invest each month or quarter. “Consistency is the key with dollar cost averaging so make certain you are financially able to invest the selected amount,” Swanson says. Select an investment that you want to hold for 5 to 10 years or longer. The key to dollar cost averaging is to keep to your schedule regardless of the price of the security.
Swanson says you may already be doing dollar cost averaging and not realize it. “If you are investing a regular amount in a 401(k) or other employer retirement plan via payroll deduction, you are already using dollar cost averaging.”
With other investing, you also can take advantage of automatic deductions by regularly having contributions deducted from your bank account.
This method of investing has a few cautions, according to Swanson. The cost of commissions to routinely purchase individual stocks may not make this approach feasible.
This means no load mutual funds that charge no sales fees can be a good choice for dollar cost averaging. Also, most mutual funds allow you to purchase fractions of shares.
With dollar cost averaging you still need to monitor your investments, Swanson says. “Regularly, for example once a year, re-examine the stocks or mutual fund to see if they are still a wise investment.”
The ISU Extension Invest Wisely Project provides a series of newspaper, radio and Web resources for investors. It is funded by a grant from the Investor Protection Trust (IPT). The IPT is a nonprofit organization devoted to investor education. Since 1993 the IPT has worked with the states to provide the independent, objective investor education needed by all Americans to make informed investment decisions. www.investorprotection.org.