What is Dollar Cost Averaging
What is Dollar Cost Averaging. How does Dollar Cost Averaging work, and will it help you make money on your investments?
(Sometimes misspelled as: dolar cost averaging)
What is dollar cost averaging? Dollar cost averaging is the new favorite media buzz word. Commentators bounce it off the screen every so often, but what does it actually mean?
How Dollar Cost Averaging Works
Dollar cost averaging means to invest a fixed amount of money in a particular investment vehicle over a certain amount of time. Thus, what happens is that if the market were to go on a uptrend, you would purchase relatively fewer shares, and if the market were to go on a downtrend, you would purchase relatively more shares.
Disadvantages of Dollar Cost Averaging
The main caveat is that recent markets have become increasingly volatile. If you are not prepared to take short term risks on your capital, dollar cost averaging would not work well for you. There would be more short-term fluctuations, though analysts believe that if you buy into the market when it is relatively underpriced, you cannot go wrong with dollar cost averaging.
Benefits of Dollar Cost Averaging
Dollar Cost Averaging helps you lower your average entry price and serves as a way for you to invest your savings regularly.
Avoid market timing
This approach also helps you avoid the folly of trying to ‘time the market’. You lower your risks by instead investing on a regular timetable, through both strong and weak market cycles. Dollar cost averaging programs will automatically lead you to buy more when the market is down and less when the market is up. The average cost of stocks in your portfolio will thus always be lower than the market price of the stocks.
Lower average cost implies higher profits
With a lower average cost, your overall profits on your portfolio will naturally be higher. Dollar cost averaging is an investment approach that works well for the long-term investor who does not need to worry about short-term fluctuations.
Dollar Cost Averaging and DRIPs
Dividend Reinvestment Plans are an excellent example of a way to regular invest a fixed amount each both. They are cost-effective and ideal for implementing dollar cost averaging.