Another technique to help soften the impact of fluctuations in the investment market is dollar-cost averaging. You invest a set amount of money on a regular basis over a long period of time—regardless of the price per share of the investment. In doing so, you purchase more shares when the price per share is down and fewer shares when the market is high. As a result, you will acquire most of the shares at a below-average cost per share.
Look at the dollar-cost averaging illustration below. One hundred dollars is invested each month. Due to fluctuations in the market, the number of shares purchased with the $100 each month varies, because the shares vary in price from $5 to $10. You can see that, when the share price is down, you acquire more shares as in months 2, 3, and 4. You benefit when/if the price per share goes up.
Dollar Cost Averaging Illustration
|Regular Investment||Share Price||Shares Acquired|
|Month 2||$100||$ 7.50||13.3|
|Month 3||$100||$ 5.00||20.0|
|Month 4||$100||$ 7.50||13.3|
Your Average Share Cost: $500 ÷ 66.6 = $7.50
As most investors know, market timing . . . always buying low and selling high . . . is very hard to accomplish. Dollar-cost averaging takes much of the emotion and guesswork out of investing. Profits will accelerate when investment market prices rise. At the same time, losses will be limited during times of declining prices. For most people, dollar-cost averaging is not so much a way of making extra money as a way to limit risk.