Dollar-Cost Averaging: How To Build Wealth Over Time

The approach works best with broad-based funds such as an S&P 500 index fund, which has performed well over long time periods. Dollar-cost averaging is one of the easiest techniques to boost your returns without taking on extra risk, and it’s a great way to practice buy-and-hold investing. Dollar-cost averaging is even better for people who want to set up their investments and deal with them infrequently. It’s one of the most powerful and easy investment strategies and it’s great for individual investors.

This can even be done automatically by reinvesting a dividend payment back into the stock itself. Make no mistake, dollar-cost averaging is a strategy, and it’s one that can get results that are as good or better than aiming to buy low and sell high. You may not have a large amount of money saved up—and waiting may cause you to miss out on potential gains. It can be stressful to invest a lot of money at once, and it may be easier psychologically for you to invest portions of a large sum over time. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation.

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Dollar cost averaging takes the emotion out of investing by having you purchase the same small amount of an asset regularly. This means you buy fewer shares when prices are high and more when prices are low. In business and finance, calculating the average cost is a crucial step in understanding the financial performance of a company or project.

Dollar-cost averaging is an investment strategy that divides the total amount to be invested across regular purchases of a target asset at consistent intervals, regardless of fluctuations in the asset’s price. So, the strategy cannot protect investors against the risk of declining market prices. Like the outlook of many long-term investors, the strategy assumes that prices, though they may drop at times, will ultimately rise. Another disadvantage is that you still need to pick good underlying investments. If you’re dollar-cost averaging into a poor investment, the way you bought in won’t save you.

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In fact, many mutual funds waive required minimums for investors who set up automatic contribution plans, the plans that put dollar-cost averaging into action. Let’s look at a hypothetical example to illustrate how dollar cost averaging works. Suppose you have $5,000 to invest and have identified a stock you would like to purchase.

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And on the 1st of every month, your hypothetical account is set to automatically buy $25 of Qualified Robotics Scientific (QRST). Before choosing dollar-cost averaging or other investment strategies, consider your financial situation and risk tolerance. Consult a qualified financial advisor to help you determine the best fit for your situation. However, dollar-cost averaging can have lower overall returns compared to lump-sum investing. It may lead to higher accumulated transaction costs due to the buying frequency. Dollar-cost averaging also tends to be inflexible when it comes to market changes.

The average cost is the total cost of producing a product or service divided by the quantity produced or sold. In this article, we will explain how to calculate average cost and provide examples to illustrate the concept. Over time, your average cost per share will be lower than the market price. Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site. Therefore, this compensation may impact how, where and in what order products appear within listing categories, except where prohibited by law for our mortgage, home equity and other home lending products.

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1. Over time, the average cost per share you spend should compare quite favorably with the price you would have paid if you had tried to time it.
2. But because most people are saving and investing as they earn money, dollar-cost averaging is the next best option.
3. This index includes hundreds of companies across all major industries, and it’s the standard for a diversified portfolio of companies.
4. While we strive to provide a wide range of offers, Bankrate does not include information about every financial or credit product or service.
5. While dollar-cost averaging won out in this hypothetical scenario, that won’t always be the case.

If you want to manage timing risk, dollar-cost averaging is the superior strategy. However, lump sum investing can provide quicker exposure to the markets and potentially generate better gains. Dollar-cost averaging is a simple way to help reduce your risk and increase your returns, and it takes advantage of a volatile stock market. If you set up your brokerage account to buy stocks or funds automatically and regularly, then you can sit back and do the things you love, rather than spend your time investing. If the price of the investment rises over the course of executing a dollar-cost averaging approach, you will end up buying fewer shares than had you made a lump sum investment at the outset. By the end of making your fixed investments at regular intervals, you would have ended up with 238 shares (compared with 250 shares if you had made a lump sum investment on January 15).

Also, keep in mind that lump sum investing only beat dollar cost averaging most of the time. A third of the time, dollar cost averaging outperformed lump sum investing. Because it’s impossible to predict future market drops, dollar cost averaging offers solid returns while reducing the risk you end up in the 33.33% of cases where lump sum investing falters.

In effect, this strategy eliminates the effort required to attempt to time the market to buy at the best prices. If you opt to go the automatic route, it requires a little more time upfront, but it’s much easier later on. Plus, it will be easier to continue buying when the market declines, since you don’t have to act. While setting up your automatic buying may seem like a chore, it’s actually easy. Mercedes Barba is a seasoned editorial leader and video producer, with an what is capital inventory in economics Emmy nomination to her credit.

Then you put it on autopilot and let your broker handle everything else. And that’s great for individual investors who want to spend as little time as possible dealing with their investments. Dollar-cost averaging can be a good strategy for steadily building wealth. It can help eliminate timing risk and also potentially reduce your average purchase price. Dollar-cost averaging is helpful for investors who may not have as much money to invest.

If the investor had spent the entire $5,000 at once at any time during this period, the total profit might be higher or lower. But by staggering the purchases, the risk of the investment has been greatly reduced. The investor keeps steadily putting $1,000 into the fund on the first of each month while the number of shares that amount of money buys varies.