06 May What is dollar cost averaging?
Q. What is dollar cost averaging? I’ve heard it’s a good way to invest so I don’t have to worry about the ups and downs of the stock market. Will it protect my money?
A. Dollar cost averaging is an investment strategy. It will help if you’re concerned about stock market moves, but it’s not a slam dunk.
When you dollar cost average, or SCA, you basically divide the total sum to be invested into equal amounts at regular intervals, said Altair Gobo, a certified financial planner with U.S. Financial Services in Fairfield. “One of the purposes of this strategy is to potentially reduce the impact of volatility.”
He offers this example: If you were going to invest $100,000 in the stock market today you could invest it all at once, or invest $20,000 per month for the next five months. You could split the money in any way, but if you’re investing over time, you’re using a DCA approach.
“DCA averaging works in markets experiencing temporary declines since not all of your investment is exposed to loss at one time,” Gobo said. “The purpose of DCA is to avoid damage from a substantial drop happening in the first few months after you’ve invested the lump sum.”
He said the technique of buying a fixed dollar amount of a particular investment on a regular schedule, no matter what the share price, helps to take the emotion out of investing. It allows you to buy more shares when the price is low and fewer shares when the price is high, thus the term “dollar cost averaging.”
If you have an employer retirement account, your automatic contributions from your paycheck are an example of dollar cost averaging, said Sheri Iannetta Cupo, a certified financial planner with SageBroadview in Morristown.
But not everyone thinks that’s the right strategy.
“Many studies, including this paper by Vanguard, have found that if you have a lump sum available for investing you would do better by investing the cash all at once than by using DCA,” she said. “Yet if it is more important to you to protect your principal and minimize potential downside risk, you may be better off using a DCA approach.
Cupo said what’s most important is that you have an investing plan that you will stick with through bull and bear markets — one that will bring you the highest probability of success over time.
“Instead of guessing when to buy and when to sell, you look to your investing plan for direction and discipline,” she said.
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This story was first posted in May 2015.NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.