The Value of Dollar Cost Averaging
If you have been itching to stick your toe into the investment waters, your best strategy starting out may be to use the “dollar cost averaging” method. In fact, you may already be using this method if you contribute monthly to a retirement savings plan such as a 401k. The principal behind the methods is that a fixed dollar amount invested each month will buy a different number of shares of a mutual fund or stock based on the price movement of the shares. When the share price declines, your fixed dollar amount will buy more shares. Likewise, your investment will purchase fewer shares when the price increases. Over time, this will have the effect of lowering your average cost of investing.
For example, if you commit to investing $300 a month into a mutual fund, and the initial share price of the fund is $20, your first investment will buy 15 shares. If the share price drops the next month to $15, you’ll collect 20 shares. In just that time, you will own 35 shares at an average cost of $17 a share. So, even though the current share price is only $15, you only need a $3 increase in the price to breakeven. As long as the share prices fluctuate up and down, you are more likely to reduce your breakeven point, and more quickly generate a profit position as share prices rise over time. The key is to maintain a disciplined approach by sticking with a fixed dollar investment amount each month.