Alternatives to timing the market.
A quick look at dollar cost averaging.
Right place, right time. It’s usually a winning combination. But when it comes to investing, finding just the right moment to get in on an investment can be worrisome and costly. Watching, waiting, trying to figure out when to pounce—even though it usually turns out to be nothing more than an educated guess. And while there are no sure things when it comes to investing, there are strategies an investor can use to help him or her make the most of what they’ve got.
One such strategy is called dollar cost averaging. More than a mouthful, it’s a systematic method that removes the crystal ball aspect of trying to time the market and replaces it with a measured, consistent approach designed around one’s budget and risk tolerance—not the unpredictable ups and downs of the market.
Here’s how it works.
Dollar cost averaging requires that an investor commit to buying a set dollar amount of a particular equity or other investment vehicle (bonds, mutual funds, etc.) at regular intervals, for a defined period of time. By using this consistent, planned approach an investor will get more shares when the price is low, fewer when the price is high, but on average he or she should end up better than if the investor relied on trying to time the market.
Here are the numbers.
Let’s say an investor has $3,000 to invest over six months. Using dollar cost averaging the investor decides to purchase $500 worth of ABC mutual fund each month, knowing the share price will fluctuate. The chart below shows imaginary share price fluctuations and how they would have affected the number of shares purchased under the program.
If the investor had taken the same $3,000 and tried to pick the ”right time“ to buy ABC shares, he or she might have wound up with 125 shares if he or she guessed right and went all in month 1 or 100 shares if he or she waited to invest it all in month 4. But with dollar cost averaging, the investor got 118 shares at an average cost of $26 a share—a nice middle ground that required no guess work, just commitment. Of course, this example is hypothetical.
A step in the right direction.
One of the good things about dollar cost averaging is that it can make regular investing a habit. Instead of socking money away for a vacation or a big purchase, the investor would be investing it with the goal of watching it grow over time.
Plus, for inexperienced or wary investors, dollar cost averaging’s gradual approach may help ease them into an investment strategy. Making smaller, timed investments over a long period of time potentially exposes fewer of their assets to any single market downturn than committing a large lump sum at one time.
Investors may already be using this technique without even knowing it. This is essentially what happens when they invest a set part of their paycheck in a mutual fund. Other financial products—like variable universal life insurance—often take advantage of it too.
Important points to consider.
- Dollar cost averaging requires that an investor determine a set amount to invest and a set schedule of investing—then just stick with it.
- It’s an easy to understand, systematic method of investing that may prove effective over the long-term.
- Dollar cost averaging is frequently used to purchase mutual funds. Over time the compounded assets may result in a considerable asset.
- Helps lower an investor’s average cost per share—Buy more when prices are low, buy less when prices are high.
- It’s a gradual step, easing uncertain investors into the market
- Remember, even with dollar cost averaging, there is no guarantee of growth or protection against loss. Investors must consider their financial ability to purchase shares continuously during periods of falling share prices, when the value of an investment may be declining.
- It may not be right for all investors, but it’s one of many approaches that can be explored.
Although dollar cost averaging does not promise profit or protect against loss, this systematic investing ”habit“ can be a great way to get into the market. Note that dollar cost averaging works best for those with long-term investment goals. It requires commitment, but if an investor is investing for the long haul it’s a simple, proven technique that can help reduce the average cost per share.
Investors should consider the investment objectives, risks, charges, and expenses of a mutual fund investment carefully before investing. Mutual fund returns and share values fluctuate; investment losses are possible. A mutual fund prospectus contains this and other information about the fund and can be obtained from your NYLIFE Securities LLC Registered Representative. Please read the prospectus carefully before investing.
NYLIFE Distributors LLC, Distributor.