Dollar Cost Averaging

Dollar cost averaging sounds like a complicated mathematical procedure. In fact, it is nothing more than an investment strategy. Dollar cost averaging is simply automatically investing a set amount of money at regular intervals for a specified investment period.

Dollar cost averaging has its fans (including Suze Orman) and its detractors. For young adults looking to build an investment portfolio, I favor dollar cost averaging.

Here are the basics of dollar cost averaging, so you can decide whether this investment strategy is right for you.

Reducing Risk

Since dollar cost averaging is based on a consistent amount, the process reduces an investor's exposure to the risk of making a lump sum investment at an inflated stock price. If an investor makes a $100 monthly investment and the stock jumps to $50, two shares are purchased. If the stock drops to $40, two and a half shares will be purchased. Over time, the basis in the stock holdings will be an average of the total of the prices at purchase. In this example, the investor ends up with four and a half shares of stock with a basis of $44.44 per share.

Automatic Investing

One of the things I like about dollar cost averaging is that many investment vehicles allow periodic payments to be set up to occur automatically. Computershare handles direct investment plans for a number of major corporations. Lump sum or period purchases can be set up with a small initial investment. Other companies, like The Walt Disney Company, manage their own plans. By setting up automatic deposits, there is no need to "remember" to invest. Also, a steady stream of small deposits can add up to a bigger investment portfolio over time than a one-shot large investment.

Investment Fees

Investment fees vary by investment plan, but, in most cases, lump sum investments incur smaller investment fees than periodic payments. Lowe's Stock Advantage Plan charges 5% of the purchase price with a maximum of $2.50. Once an initial deposit of $250 is made, monthly deposits can be as small as $25. Twelve monthly deposits of $25 each would incur annual fees totaling $15. If one annual investment of $300 was deposited in the plan, the investment fee would be maxed at $2.50.

Small Dollar Amounts

Many corporate investment plans allow for monthly deposits of as little as $25. Some will allow you to start with only a $50 initial investment. While making lump-sum investments may incur smaller investing fees, young adults do not always have large, lump sum amounts available for investment. Doing something is better than doing nothing.