Dollar-Cost Averaging

Investment Dictionary -> Dollar-Cost Averaging

When we buy on a regular schedule a fixed dollar amount of a particular investment regardless of the share price, we employ Dollar-Cost Averaging. Typically, fewer shares are bought when the prices are high.

The average cost per share of security tends to become smaller over time. The risk of investing a larger amount of money in a single investment at the wrong time is lessened by the dollar-cost Averaging. Putting a particular amount of money monthly into a stock, mutual or index fund, is what DCA is all about. An automatic monthly withdrawal service will be set up by most banks. DCA proves just perfect for those of the investors who cannot afford a big lump sum at the start. It enables them to invest small amounts on a regular basis.

The markets, though having bad days or even years, go up over time. For example during the last century, U.S. equity markets have appreciated by nearly 11% average every year. Each month, investing a set amount of money enables one, if the market is high, to buy fewer shares. He will do vice versa when the market is low. The fixer amount may buy, for example, 10 shares when the price is low and only 5 shares when it is high. Therefore, the risk of investing a larger amount at the wrong time and in a single investment is lessened by the DCA.

Some people are asking if it is not more profitable to buy as much as possible when the market is low and try to dispose of everything when it is high. They are right but a professional investor will warn that it will require extraordinary abilities to get a correct prediction. No one is able to stop the surprises and no one really knows when the tops and bottoms are going to occur.

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