Dollar-cost averaging — regularly investing money in the market — is an age-old strategy for mitigating investment price risk. Commonly applied by 401(k) plan savers, it could also be a useful strategy for experienced investors with larger sums, especially during periods of uncertainty or when emotional reluctance is high.
Dollar-cost averaging: the theory behind the practice
Dollar-cost averaging involves regularly investing a consistent amount of money to purchase a specific asset, or group of assets, regardless of their price. For example, an employer-sponsored 401(k) plan is set up this way. With each paycheck, you invest a regular percentage of your earnings in defined assets, generally mutual funds, that you have previously selected.
This strategy helps prevent you from stressing over decisions on when to invest in the market. With the regular-investment approach, you don’t focus on whether the asset you’re purchasing is at a good price for purchase. Rather than try to time the market, you buy it each week or month or whatever the interval is.
The theory underpinning this strategy is that asset prices will go up and down in unpredictable ways, and if you buy shares regularly, the average share price you pay – that is, the dollar-cost average – won’t be too high. When prices are lower, your money will buy more shares than the same amount will buy when prices are higher, bringing down your price-per-share cost. This, in turn, can help reduce the impact of market volatility on your portfolio.
Potential benefits and limitations of dollar-cost averaging
When you’re traveling, you may be programmed to make the most of every minute at your destination. But, if you’re traveling with aging parents and possibly little ones, consider keeping some kind of routine. If you keep the same bedtimes or mealtimes, it can help, especially if your parents have medical issues that require timing medication, for example. Go with the flow and realize you might need to take things slower than usual.
When vacationing with a big group, keep everyone organized by making an itinerary. While it can feel controlling, it’ll ensure you all get time together – and apart. Schedule in breaks so that people get their personal time and know when they can rest. Younger family members may opt to check in with their friends on devices and older family members may decide to put their feet up for a bit. While the trip is about spending time together, everyone needs alone time, especially if you’re with those you normally don’t spend a lot of time with.
If you feel the pressure to do all the planning, find a few preplanned activities that don’t require too much preparation. Maybe it’s a sightseeing bus tour, where you don’t have to do the research about where to stop, or a class of some kind, like a wine tasting where you can just partake and enjoy with the group. This will help you relax too, instead of trying to do all the organizing yourself.
Another option is to share the responsibility of planning. Give others a chance to be a tour guide for the day. Your mother-in-law might think of an activity or book a restaurant you wouldn’t have considered, which can make the trip more interesting. Assign a daily activity to a few different family members or even just ask them to pick where breakfast will be the next day. This will not only spread around the responsibility but also allow everyone to incorporate their own wishes into the vacation.
Another approach: lump-sum investing
Given that time in the market is often an advantage, investing all your money at once could be more effective than investing it incrementally over time. This all-in approach is known as lump-sum investing.
Lump-sum investing can be an effective strategy given certain market conditions. For example, in a rising market, particular assets will rise in price on average, so investing a lump sum at the outset can enable you to acquire more shares, and therefore more value, compared to investing fixed amounts over time.
But if you invest all your money at once, and the price drops, you may suffer losses that could persist for a few years or longer. Under these conditions, dollar-cost averaging would lead to owning more shares.
With dollar-cost averaging, you can avoid the risk that you’ve mistimed the market.
Choosing the right strategy for you
There’s no one-size-fits all answer when it comes to your investment strategy. Whether dollar-cost averaging is the right strategy for your investment goals depends on multiple factors, including the time horizon to your financial goal, your available cash, market conditions, and investment opportunities.
Your financial advisor can help you weigh these different considerations and make a choice that feels right for you.
There is no assurance any investment strategy will be successful. Investing involves risk including the possible loss of capital. Dollar cost averaging does not assure a profit and does not protect against loss. It involves continuous investment regardless of fluctuating price levels of such securities. Investors should consider their financial ability to continue purchases through periods of low-price levels.
Sources: forbes.com; cnbc.com; etrade.com; ndvr.com; aarp.org
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