Dollar cost averaging is an investing method that takes advantage of changes in market price over long periods of time. Investors do this by investing a set amount of money, rather than purchasing a certain number of shares, ensuring that their investment buys more shares when prices fall.
In dollar cost averaging, an investor will invest a certain amount of money in an investment at regular intervals. For example, an investor might choose to purchase $100 of a mutual fund every month. When the mutual fund has a high price, that dollar amount will purchase less. However, when the price falls, the same dollar amount will purchase more. This investing technique protects the investor from the possibility that the share price will drop after making a stock purchase.
Dollar cost averaging is usually done over long periods of time time, particularly with long-term investments to which a person plans to contribute regularly. This helps investors ensure that they pay a mix of higher and lower prices for the investment, rather than taking the risk that a particular day's price might be high or low. By investing a set amount over time, investors help take advantage of the rise and fall of prices in the market. However, investors can also use the same method to invest a substantial deposit, breaking it up into multiple smaller deposits over a certain period.
This investment technique is different than other methods, in which investors might try to guess when market prices will be low and try to invest at the right moment. Instead, dollar cost averaging ensures that investors are purchasing at regular intervals and are able to take advantage of market slumps by automatically buying more of an investment for the same amount of money. Dollar cost averaging takes some of the guesswork out of investing.
Many investment companies make it easy for investors to use dollar cost averaging. The companies will often allow investors to set up automatic investment plans, in which investors can specify the dollar amount and frequency of the investment, as well as the bank account where funds can automatically be withdrawn. By doing so, dollar cost averaging is made automatic, ensuring that an investor does not forget to make a scheduled purchase. It also helps make investing easier to budget, as the same dollar amount will be purchased at regular, predictable intervals.