Dollar-cost averaging: What this strategy is & how to use it | finder.com (2024)

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Dollar-cost averaging: What this strategy is & how to use it | finder.com? ›

Dollar-cost averaging involves investing the same amount of money in a target security at regular intervals over a certain period of time, regardless of price. By using dollar-cost averaging, investors may lower their average cost per share and reduce the impact of volatility on the their portfolios.

Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

Dollar-cost averaging is the practice of investing a consistent dollar amount in the same investment at regular intervals. 1 Investors looking to reduce investment risk frequently consider this strategy. While this approach might help you better manage risk, you are less likely to have outsized returns.

--The result of dollar cost averaging is to obtain a lower average cost per share than the average price per share. --This is accomplished by making regular investments of a fixed amount when prices are fluctuating.

Dollar-cost averaging allows you to manage some risk on entry, but lump-sum investing, plus portfolio management strategies like rebalancing, may provide the best of both worlds: putting money to work more quickly along with risk management throughout the lifetime of your investments.

With dollar-cost averaging, you are investing a pre-determined amount every month, regardless of what the price of the underlying asset is. The idea here is that when the price drops, you buy more, and when the price increases, you buy less. In this manner, you create the potential for investment gains down the road.

The technique is so called because of its potential for reducing the average cost of shares bought. As the number of shares that can be bought for a fixed amount of money varies inversely with their price, DCA effectively leads to more shares being purchased when their price is low and fewer when they are expensive.

In value averaging, one would invest more when the price or portfolio value falls and less when it rises. Value averaging involves calculating predetermined amounts for the total value of the investment in future periods, then making an investment sized to match these amounts at each future period.

Buffett was essentially saying that when accumulating investments, be more aggressive when prices are low and less aggressive when they're high. That's dollar cost averaging in a nutshell.

Which of the following is an example of dollar-cost averaging? ›

Example of dollar-cost averaging

Imagine an employee who earns $3,000 each month and contributes 10 percent of that to their 401(k) plan, choosing to invest in an S&P 500 index fund. Because the price of the fund moves around, the number of shares purchased isn't always the same, but each month $300 is invested.

The theory behind this strategy is that you reduce market timing risk – instead of investing your entire allocated amount in one lump sum, you can spread your investment out over a period of time. Depending on market movements, spreading out your entry points potentially can achieve a lower average cost base.

For spread-load plans (from the amended Act of 1970), the maximum sales charge over the life of the plan is 9%, with no more than 20% levied in any one given year. The result of dollar cost averaging is to: The result of dollar cost averaging is to obtain a lower average cost per share than the average price per share.

The strategy couldn't be simpler. Invest the same amount of money in the same stock or mutual fund at regular intervals, say monthly. Ignore the fluctuations in the price of your investment. Whether it's up or down, you're putting the same amount of money into it.

A general rule is that with the lump-sum approach, investors may generate somewhat higher annualized returns than dollar-cost averaging.

Among the numerous investment strategies available, dollar-cost averaging is a popular and widely used approach. Its proponents range from Warren Buffett to average investors.

The calculation for dollar-cost averaging works the same as calculating the average or mean for a set of numbers. In the case of DCA, the investor adds investment purchase prices, then divides the sum by the amount of purchases made.

Most investors prefer the monthly dollar cost averaging method. This is a more familiar frequency to those used to a SIPP plan where funds are taken directly from your salary and invested into your investment account.