Financial Literacy Friday: Dollar Cost Averaging

Welcome back to another edition of Financial Literacy Friday where we’ll be talking about Dollar Cost Average and how it can be a useful strategy for those who are just starting their investment experience.  Dollar cost averaging simply means that you’re buying an investment with a set amount of money at regular intervals. This strategy is used in 401k accounts and allows you to invest over time as opposed to putting up a lump sum which may not be possible depending on your situation.  That being said, let’s look at how dollar cost averaging works in practice.

How It Works

Dollar cost averaging works by taking a fixed amount each month and investing it into the same investment, whether that’s mutual funds, Exchange Traded Funds (ETF’s), or individual stocks.  When the market dips, that same amount will buy more shares of that investment, and when the market goes up that amount buys less. The value in doing this is that for those worried about timing the market or unsure of when to get in or out of the market altogether, this helps reduce that stress as it frames investing in new way.  If you’re going to invest a set amount every month, you’re either going to get more shares or less shares and the power is being able to average the amount you’ve paid for the investment over time. This doesn’t guarantee you won’t lose money, but it does serve as a solid framework to begin your investment experience.

Pros/Cons

One of the biggest pros to dollar cost averaging is that you’re able to make the process fairly mechanical and take some of the emotion out of investing.  Instead of purchasing a specific investment in a lump sum and then dealing with the up and downturns of the market viscerally, you’re able to distance yourself from those emotions and look at it like any other subscription based service.  It’s no longer fearing a market swing but realizing that this month you’ll be able to buy more with the same amount of money as last month. This also means that you don’t have to worry about finding the perfect entry point, as it’s going to be a set amount anyway, so it doesn’t particularly matter when you get started.  While this strategy allows you to mitigate some of the downsides, it does limit some of the upsides of investing. If you’re dollar cost averaging and the market takes off, you’re likely to miss some of the great opportunities that follow.

This can be a great strategy for those who are just starting their investment experience or are hesitant about the ups and downs of the markets.  Have you used a dollar cost averaging strategy before? Would you in the future? What’s your preferred style of investing? I’d love to hear what works for you, so let me know via email about your experience.