What is dollar cost averaging and how do I know if it's right for me?
Dollar cost averaging is a method of accumulating assets by purchasing a fixed dollar amount of securities, at regularly scheduled intervals, over a period of time (for example, $100 per month over the next five years). When the price of the securities is high, your fixed dollar amount will buy fewer securities, but when the price of the securities is low, your fixed dollar amount will buy more. For example, when your share price is $25 your $100 will purchase four shares, but when the price drops to $20 it will buy five shares. This allows you to take advantage of fluctuations in the market. As a result, dollar cost averaging with a fixed dollar amount should yield a lower average per share price than if you bought a fixed number of securities for each periodic interval.
Note: 401(k) contributions are a good example of dollar cost averaging, because they are deducted from each of your paychecks and then sent to the investment company.
Dollar cost averaging is often favored by those who wish to make their periodic investment a part of their monthly budget. The amount invested each month is predictable. An automatic investment plan (such as a systematic electronic draft from your checking account) will ensure that the predetermined amount is properly invested at appropriate intervals. Among other things, this relieves you of the concern and emotional burden that comes with trying to decide when, and how much, you should be investing when the price of your securities is rising or falling. Experts suggest that this strategy works best with a single investment vehicle that regularly fluctuates in price.
Remember that since dollar cost averaging involves continuous investment in securities regardless of those securities' fluctuating prices, you should consider your ability to continue purchases through periods of low price levels.