How to Use Dollar-Cost Averaging

Money Bags

What should you do when you have a large chunk of money to invest? Deciding whether to invest it immediately or wait for what you think is the right time can be a difficult decision.

Markets go up more often than they go down, so in theory you should invest your money as soon as possible in order to “put it to work” and have the best chance of maximizing your wealth. But markets certainly don’t always go up, so investing a lot of money at once can be nerve-wracking. Markets could fall shortly after you make your investment, and you could easily regret your decision.

A more comforting alternative may be what’s called “dollar-cost averaging,” which means periodically investing a portion of your money over a preset period of time. For example, instead of investing all at once you could invest 25% of the money every 3 months over the course of a year. If markets fell right after you started investing, only 25% of your money would have been affected (and the fall in prices would actually increase the number of shares you can afford to buy with the remaining 75%). Part of the appeal of this procedure is that by having a set plan rather than taking a more ad hoc approach, you can ensure that you’ll be fully invested by the end of the one year period.

Those benefits don’t mean that dollar-cost averaging is always the best tactic. If markets go up rather than down you’ll give up some gains during the time when you’re only partially invested. But giving up some potential gains may be worth the peace of mind that comes with having a well-defined plan that reduces your exposure to the possibility of an imminent market drop.

Topics: Blog Dollar-Cost Averaging