Dollar Cost Averaging as an Investment Technique

What Is Dollar Cost Averaging?

Dollar cost averaging is an investment technique by which you purchase an investment in increments at predetermined intervals and at preset amounts. The idea is that by building your position little by little over an extended period of time, rather than purchasing an investment all at once in a lump sum, you can purchase more shares when the price is low and fewer shares when the price is high. This is because when the market price of the shares is lower, your fixed amount in dollars will buy more shares, and when the price is higher, the same fixed dollar amount will buy fewer shares. By using dollar cost averaging you are in effect building your position at the weighted average price of the shares over the period in which you invest.

Dollar cost averaging is intended as a way of mitigating the risk involved in the timing of your investment. If you purchase your investment in a lump sum, and the market price subsequently drops, you will have lost the opportunity to have purchased the same number of shares at a lower price. On the contrary, if you purchase your investment in a lump sum and the market price subsequently goes up, you will have taken advantage of the lower price. If you could predict the way market prices will go, you could time your investment so that you purchase the entire investment at the lowest price. But since it is difficult to predict how market prices will fluctuate, dollar cost averaging is a way of smoothing out the fluctuations and protecting yourself from volatility.

Considerations

Dollar cost averaging is intended as a technique for building a position at the average price over an extended period of time. This will affect the eventual return on your investment since it affects your cost basis in the investment. But while dollar cost averaging evens out the price fluctuations that determine your cost, it is no guarantee of the profitability of your investment. Your return will depend on the market price of your investment at the time you decide to sell.