What is Dollar Cost Averaging and is it Right for You?

Dollar cost averaging is a strategy in which you will invest a certain amount of money at regular intervals in order to average out your investment cost over time. The strategy is a great way to tackle buying mutual funds or even stocks and all it requires is an investment vehicle that will allow you to conduct the dollar cost averaging and the discipline to do so.

The idea behind dollar cost averaging is to buy more shares of an investment when the price is down and buy less of the shares as the price goes up. This keeps your overall average down and provided that the investment goes up over your average after a certain amount of time you will make money.

I had to explain this strategy a lot when I was a stock broker and I usually recommended this strategy for those who were investing in mutual funds that were not front end load (meaning a commission is charged with every purchase). The reason I recommended mutual funds was because if you bought a no load mutual fund (mutual funds that charge no commissions only a small yearly percentage) then you can easily set up an automatic withdrawal from your bank account and for as little as $50 you can build your portfolio slowly over time.

Stocks did not typically make a good investment vehicle for this type of investing unless a person has a lot of money to invest every month because with stocks there is always a commission being charged whether you buy one share or one hundred shares. However, that has all changed and there are now services such as Sharebuilder that will allow you to buy even partial shares of certain stocks and will only charge you around four bucks per investment no matter how much you buy so long as you practice dollar cost averaging.

Deciding if dollar cost averaging is right for you is really a matter of what you want. If you are young and have a lot of time before you retire then you can set up a ROTH or traditional IRA with one of many mutual fund companies and start it with as little as $100. Then you can sign up to have monthly withdrawals taken from your checking account for as little as $50 to whatever you want per month. Every time a withdrawal is taken from your account the money will be used to buy as many shares of the mutual fund as it can. When the price of the mutual fund is down, your money will buy more, if the price of the mutual fund is up your money will buy less.

If you are the type of investor that is always trading this and always trading that then dollar cost averaging probably isn't for you. Before you make any financial decision you should be sure to speak with your financial advisor and ask them for more information on dollar cost averaging.

It has been said that investing is a marathon, not a sprint. The method of dollar cost averaging practices just that and can be a great tool for you so long as you have the patience and strong will to just let the strategy lie and do its thing over time.

Source: Joshua Kennon, Dollar Cost Averaging, About.com