Dollar Cost Averaging- A Smart Investment Strategy

Dollar Cost Averaging: A Smart Investment Strategy

Dollar cost averaging is a smart way to invest in the stock market and build your wealth while minimizing your financial risk.

Interested in building your wealth by investing in the stock market - but not really interested in a lot of risk? Dollar cost averaging may be your answer. It's perfect for beginners and for those who don't have large amounts of money to invest. In fact, if you're contributing to a 401(k) plan, you're already doing it.

What exactly is dollar cost averaging? Simply put, it means slowly buying smaller amounts of stock over a longer period of time. It involves the steady purchase of securities at regular intervals and set amounts. This type of investing is beneficial because it spreads the cost out over several years and helps protect you against changes in market price.

There are basically three things you need to do to start a dollar cost averaging plan:

1. Determine how much money you can invest each month. Make sure it's an amount that you will be able to keep consistent. That's the key to having the most effective plan.
2. Select what you'd like to invest in. Keep in mind that you'll want to keep this investment for five or ten years or even longer.
3. Decide how often you'll invest (weekly, monthly or quarterly works best), and then invest your predetermined amount of money into the security you’ve chosen. Some brokers offer an automatic withdrawal plan, and if yours does, take advantage of it. That way both the amount and the frequency will remain consistent.

So now that you know how to implement a dollar cost averaging plan, what should you invest in? One of your best investment bets is mutual funds. Remember, a mutual fund is simply a collection of stocks and/or bonds, and each investor owns shares, or a portion of the fund. One of the advantages of investing in mutual funds is the professional management of your money. For a relatively inexpensive fee, you get a professional to make and monitor investments for you. Other advantages include diversification, which spreads your risk among many different investment vehicles, lower transaction costs and the ease of investing. Most banks have their own line of mutual funds and offer low minimum investments.

You may be wondering how your investment will grow with a dollar cost averaging plan. As market value changes, your buying power changes with it. When the market is up, your fixed investment amount gets you fewer shares per dollar due to the higher cost per share. When the markets are down, your dollar buys a greater number of shares. So when the the cost is low, you can buy more shares with your fixed investment amount. And after five or ten years or even longer, you'll be amazed at how much you've accumulated.

For beginning investors, dollar cost averaging makes perfect sense. It requires patience and consistency, but if you stick to your plan, the benefits are well worth it.