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Dollar Cost Averaging
Dollar Cost Averaging is the process of systematically investing an equal dollar amount, on a scheduled basis (weekly, monthly, quarterly, etc.), into the same investment over an extended period of time. There are no steadfast rules as to the amount of money, the length of the time interval, or the overall time period in which you become fully invested. An individualized plan can be made based on your risk tolerance and the characteristics of the underlying investment.
When used consistently, Dollar Cost Averaging can be an effective tool in minimizing the potentially harmful effects of market volatility. It accomplishes this goal by ensuring that all your money does not go to work at a time that turns out to be a market high.
For example, assume you’ve identified an investment that you will dedicate $12,000 to. Rather than putting the $12,000 to work all at once, you might invest $1,000 a month for the next 12 months. Based on your risk tolerance and the characteristics of the underlying investment, you might change that to $2,000 a month for 6 months, or $500 a month for 24 months.
Another potential advantage of Dollar Cost Averaging is that it may allow you to accumulate your investment at a price that is lower than the average price over the time period in question (assuming that the underlying investment has a share price that moves up and down, like a stock or a mutual fund). This happens because when you invest an equal dollar amount periodically, you end up buying shares at many different prices. As a result, when the share price is low, you buy more shares than when the share price is high.
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