What is dollar-cost averaging?
Dollar cost averaging is strategy where you invest the same amount of money on a regular basis, regardless of the price of the investment.
For instance, say you invest $100 every month. When the market is rising, your $100 will buy fewer units, but when the market is falling, your money will buy more. Over time, investing this way can lower your average cost per unit - compared to what you’d have paid if you'd bought all your units at the same time when they were more expensive than the average.
Benefits of dollar-cost averaging
While reducing the average unit cost of your investing, dollar-cost averaging also offers these benefits:
- Disciplined investing habits – Especially when you invest through automatic payroll deduction, you won’t spend the money on something else, or forget to invest, helping you stick to your plan.
- Removes emotion from investing – Because you’re investing smaller amounts over time, you’ll be less likely to get upset if your investment falls in value.
- Keeps you in the market – Instead of trying to buy your investment at its bottom price and sell at its top price (called market timing, which is virtually impossible), dollar-cost averaging keeps your money invested so it’s there when the market surges.
- Ideal for new investors – Because it allows you to invest small amounts, it’s perfect for investors who are just starting out.
- Good investment results – Dollar-cost averaging may achieve investment performance results that are as good or better than investing by timing the market.
Should you invest a lump sum with dollar-cost averaging?
If you get a bonus or another cash windfall and decide to invest it, it’s likely smarter to invest it all at once instead of dividing into several installments. Keeping it as cash instead of investing it could mean missing out on potential investment gains.