Dollar-cost averaging (DCA) is a common investment strategy designed for secure, conservative investing over time. Here’s how it works:
In DCA, an investor buys a fixed dollar amount of shares in a company over a particular period of time regardless of the share price. This means that more shares are purchased when the price is low, and fewer shares are purchased when the price is high. For example, Susan decides to invest $100 a month in a particular stock. In January, the share price was $25, getting her 4 shares. In both February and March, the shares price was $20, netting her 5 shares in each month. So Susan bought a total of 14 shares at an average price of about $21.43 per share. Had she bought all 14 shares in January, when prices were high, she would have had to pay $25.00 per share, a much higher average cost.
Dollar-cost averaging has several advantages. It allows investors to buy stock without worrying about getting in or out of the market at a particular time. Money is slowly spent over time rather than all at once. Overall, it is considered to be a relatively safe strategy that can be applied to mutual funds and ETFs, as well as individual stocks. However, as with any investment, it is still possible to lose money. In a market where shares are projected to rise in price, investing some money later rather than all money now may not always be the best option, assuming an initial lump sum is available. The trade-offs involved in DCA are also a subject of debate among behavioral economists. Dollar-cost averaging should also not be confused with continuous, automatic investing.
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