Investment Perspective: The Pros and Cons of Dollar Cost Averaging

One investing technique often recommended by financial advisors is dollar cost averaging or investing a set dollar amount in a stock or other equity investment on a regular schedule. If you participate in a corporate stock purchase plan and have a predetermined amount from each pay check invested in your employer's stock or if you put a set amount each month in a 401(k) for investment in a stock mutual fund, you are already dollar cost averaging. One result of dollar cost averaging is that you automatically buy more shares when the share price if down and fewer when it is up.

As with any investment strategy, there are both pros and cons to dollar cost averaging.

Pros of Dollar Cost Averaging

It is simple and easy to understand. Dollar cost averaging is a straightforward approach to investing. You make three decisions up front: what you want to buy, how much (in dollars) you want to invest with each purchase, and how often you want to invest. Once you make those decisions, you can notify your brokerage firm and arrange for the investments to be made automatically. Some companies even offer potential and current shareholders a direct purchase plan, which allows them to schedule stock purchases in predetermined dollar amounts directly from the company, avoiding brokerage fees. Even better, if the company's stock pays a dividend, you may be able to supplement your direct purchases by having dividends automatically reinvested in the stock.

It takes the emotion out of the investment decision. Emotion often can cloud our judgment when it comes to making investment decisions, causing us to hesitate to purchase additional shares when the price has fallen and to be gung ho to buy more shares when the price has risen. With dollar cost averaging, you automatically purchase more shares when a stock's price is down and less when it is up.

It is ideal for investors with limited funds who can't take a full position up front. Even if you would like to establish a large position in a particular stock, you may not have the money to do it all at once. Dollar cost averaging can be a great way to purchase the shares over a period of time.

Cons of Dollar Cost Averaging

Transaction costs can be high. Implementing a dollar cost averaging stock purchase program through a broker, even a discount broker, can be costly, since you will pay brokerage fees on each purchase.

Recordkeeping may be burdensome for a dollar cost averaging program. If you dollar cost average in a taxable account, it is critical to keep track of all your purchases so that, when you sell your shares, you can calculate your average purchase price and determine which shares you have held long term and which you have held short term.

Dollar cost averaging will not necessarily result in better long-term investment results than purchasing the same number of shares at once. In some cases it may, but, in others, you may be better off with a buy up front and hold strategy.

You will still need to do research and pay attention to your investment. Whether you purchase shares in one fell swoop or over time through dollar cost averaging, you will still need to keep a close eye on the company whose shares you own to be sure that there has been no negative change in its business that would warrant selling the shares or deferring additional purchases.

Sources:

Ryan, cashmoneylife.com , Pros and Cons of Dollar Cost Averaging

www.money-zine.com , Dollar Cost Averaging

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