Dollar Cost Averaging: An Overview

One of the ways that you can build wealth for your future is to invest.

In the past, investing presented problems for those who didn’t have a large chunk of capital. Now, though, investing is possible for just about anyone. Thanks to the rise online brokers and increasing popularity of funds, it is possible for you to get started with $50, and a relatively small amount of money each month.

With the help of dollar cost averaging, you can build your portfolio in small increments — and even be somewhat protected against the ups and downs of the markets.

What is Dollar Cost Averaging?

When you get involved in dollar cost averaging, you choose a set amount of money to invest every month. You can invest this money via your retirement plan, or through a brokerage account. (It’s usually a good idea to max out your tax advantaged retirement plans before using a regular brokerage account, though.) Every month, the money you invest is used to buy shares in your chosen investment. You invest the same amount every month, but the number of shares you buy changes, since the stock market is always changing.

For example, let’s say you decide you can invest $100 a month. You choose a fund with a share price of $50. Your $100 buys you two shares. The next month, though, things have been going well. The share price rises to $75. Now you can only buy 1.33 shares. (One of the great things about dollar cost averaging is that you can buy partial shares.)  Next month, there is a huge stock market drop. Your $100 buys shares on a day when the price has plunged to $20 a share, so you get five shares.

In the end, though, many believe that your gains over time average out, since your regular investment buys more during down markets and less during up markets.

Advantages to Dollar Cost Averaging

The main advantage to dollar cost averaging is that you are consistently investing. If you set up an automatic plan you don’t even have to worry about making sure that you pay; it happens at the same time each month. You are getting in the habit of putting money aside for the future, and building your wealth.

Another advantage to dollar cost averaging is that you can get started with a relatively low amount of money. If you are investing in a fund, or if you open an IRA, most brokerages will allow you to start with as little as $50, and put in as little as $50 a month. Dollar cost averaging makes investing accessible to just about anyone.

It is true, though, that you can miss out on some investing opportunities with dollar cost averaging. If you want to take better advantage of stock market dips, you will need to have a reserve of capital that you can use to buy more when stocks go on sale. Also, since many people have dollar cost averaging on automatic, your investment happens the same time each month. This means that you might miss the opportunity to pick up more for your money by a day or two; it’s a good idea to be ready for those opportunities, and invest extra, while leaving your dollar cost averaging plan in place.

If you are looking for a way to start investing in an affordable manner, and if you don’t want to worry too much about stock picking, dollar cost averaging might be a strategy that works for you — and that can help you build your portfolio.

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