When the economy and the stock market send mixed signals, investors inevitably ask, “Is this a good time to invest?” But without a crystal ball, you’ll never know for sure when to move in and out of the market — and if you guess wrong, you could miss out on the market’s best days.
A better approach for uncertain markets may be to use an investment process called dollar cost averaging (DCA).
A Systematic Strategy
The idea behind DCA is a simple one: Instead of trying to “time the market” — and potentially buying or selling at the wrong time — you invest a set amount of money at regular intervals. This means that you automatically buy more shares when prices drop and fewer when prices rise. When you compare the higher and lower share prices you’ve paid over time with the number of shares you’ve accumulated, you may see an interesting trend develop: The average cost per share may be lower than the average price per share.
Say, for example, you invest $100 a month in mutual fund shares. During the first six months of the year, the share prices you paid were $12, $9, $7, $10, $8, and $9. That means you purchased 8.3 shares in the first month, 11.1 shares in the second, 14.3 in the third, 10 in the fourth, 12.5 in the fifth, and 11.1 in the sixth. Spread out over six months, your average price per share would have been $9.17, but the average cost to you per share would have been lower — $8.92.
Easy Does It
Dollar cost averaging puts the decision of when and how much to invest on autopilot. Since your investment moves are consistent and automatic, it helps you ease into investing, potentially eliminating much of the guesswork and jitters, while potentially letting the market’s short-term price fluctuations work in your favor.
Although dollar cost averaging cannot guarantee a profit, nor protect you from losses, for investors whose goals are long term, it may be one investment habit worth forming.
Article from the Financial Planning Association