Dollar Cost Averaging is an extremely effective way to produce above-average long-term gains. It’s easy, it can be started with a small investment, and it works. Simply put, dollar cost averaging is the practice of buying securities at regular intervals in fixed dollar amounts, regardless of market conditions. Small investors have built fortunes by making systematic purchases of shares over long periods of time. For instance, by investing as little as $50 monthly in mutual funds, you can take advantage of dollar cost averaging, which is one of the simplest and most efficient ways of building an investment portfolio. The principle can also be used to purchase individual stocks and bonds; however, larger investment amounts are generally needed to purchase these.
When using this technique, you purchase more shares at relatively low prices than at high prices. As a result, the average cost of all shares bought is lower than the average of all the prices at which the purchases were made. The combination of buying shares at a variety of prices and acquiring more shares at lower rather than higher prices has proven to be a resourceful as well as cost-effective way of accumulating securities.
Dollar cost averaging works because an equal number of dollars buys more shares at low prices than it does at high prices. As long as share prices change at all during the investment period, the average cost of the shares purchased will be lower than the average of the prices paid. Long-term growth of the investment is not the main concern. The fluctuations of the share prices are more important to the success of this technique. Markets of greater volatility will in fact produce the best results. A conservative fund, such as an income fund where price movements are small, will not work as well.
It must be remembered, however, that dollar cost averaging does not guarantee that there will always be profits and never be losses in your portfolio. No investment can guarantee that. Even though you paid a lower average cost than the average price of the shares, if you choose the wrong time to exit the market, you could still lose money. If the market price is low when you get out, you won’t make a profit.
This program should be used only for long-term investment purposes. Over the years of continual systematic investing, shares are bound to be purchased at various price levels from high to low and in-between. This can substantially reduce the risks inherent in securities investing. The plan’s main advantage is that over time it will work to your benefit almost regardless of what the market does.
Building wealth by investing in stocks, bonds, or mutual funds is less a matter of investment skill or luck than of patience and persistence. The major decision that must be made is whether or not you are willing to forego immediate gratification to achieve your long-term financial goals. If you are, then dollar cost averaging can be a very effective way to help you get there.
