- Making consistent investments helps manage the uncertainty that comes with changing market conditions.
- Maintaining a steady investment strategy may help you make progress toward your financial goals and avoid costly mistakes.
Investing over the long term means that you’re likely to encounter periods of uncertainty or volatility. And that may make it tempting to try to “time” the market, investing during periods when the market is up and withholding investments or even taking money out when there are dips. The challenge is that timing the market is almost impossible. If you miss the start of an upturn or a particularly good day in the market, you could lose significant potential for returns.
But there is a way to hedge your investments to minimize concerns about timing the market. A solid strategy to consider is to invest regularly over time to potentially reduce the impact of volatility. This is called “dollar-cost averaging.”
How dollar-cost averaging works
Dollar cost averaging simply means that instead of making one big investment with a lump sum of money, you make smaller purchases at regular intervals over time. As a result, you don’t need to think about market timing, so it takes the emotion out of investing and reduces the risk that you’ll make a big purchase on a day when prices spike. Automating this approach may make it easier to stick to your investment plan over time, too.
Dollar-cost averaging in action
Consider this hypothetical example: Say you were planning to make a $6,000 contribution to your IRA and use that money to buy a particular stock. You could watch the stock price over the course of days, weeks, or months and try to pick the best time to invest your full $6,000 contribution. But that process can be stressful, leaving you with doubts about when to invest.
With dollar-cost averaging, you could instead break that $6,000 contribution into $500 monthly investments, which means paying a different price per share each month.
|MONTH||INVESTMENT||SHARE PRICE||SHARED PURCHASED|
|April||$500||$60||8||Buy more shares when prices are lower|
|September||$500||$135||3||Buy fewer shares when prices are higher|
|AVERAGE PRICE PER SHARE $92|
With this approach, you may avoid the worries about choosing the right time to buy shares — and get the benefit of buying more shares when the price is lower.
One thing to keep in mind, though, is whether your financial institution charges a transaction fee for each investment purchase. Also, Dollar cost averaging does not assure a profit or protect against a loss in declining markets. Since such a strategy involves continuous investment, the investor should consider his or her ability to continue purchases through periods of low price levels.
Invest with discipline
You may want to consider dollar-cost averaging as the next step in your financial plan if you already have an emergency savings plan funded. Dollar-cost averaging can help you manage the uncertainty about when to put your money to work toward your long-term financial goals. And by adopting a regular repeating process based on your goals, you may find it easier to stick with that investment plan.
If you’re already contributing a portion of each paycheck to your employer-sponsored retirement plan or individual retirement account, you’re already practicing dollar-cost averaging in your investment plan. As you have extra funds to invest, consider dividing them over a period of time and investing in regular intervals rather than trying to “time” the market.
A regular investing strategy may help you stay focused on your long-term goals, instead of the market’s day-to-day movements.