Whether you're a novice investor or you've been following the market for years, one thing you know is true: The market is constantly changing.
The never-ending ups and downs can make it hard to determine when would be a good time to buy. Fortunately, there is an investment strategy that can help compensate for swings in the market and make the decision a little less troublesome for you.
A widely recognized investment strategy known as dollar cost averaging offers a systematic approach to investing. By following this plan, you invest a specific dollar amount at set times, regardless of where the market may be at the time. One of the advantages of this strategy is that it can be applied to a wide variety of investment vehicles.
As you know, the market price of an investment fluctuates. By using dollar cost averaging, you can buy more shares when the price is low, but you buy fewer shares when the price is high. While that seems fairly elementary, the interesting thing is that by spreading out your investment dollars this way, the average cost you pay per share can actually end up being lower than the average price per share over an extended period.
This example illustrates how this can happen:
Let's say you decide to invest $500 a month in a certain investment on the first of the month, and monitor that plan over a five-month period in the market. For illustrative purposes, we'll say the market prices at the beginning of each of those months are $10, $8, $6, $5, and $8. Your steady $500 investments would buy you 50 shares the first month, 62 the next, and then 83, 100, and 62 again in the subsequent months.
By the end of that five-month period, your total investment of $2,500 will have bought you a total of 357 shares. That amounts to an average cost per share of $7. However, if you take those five prices on your purchase date and divide, the average price per share over that same time period was $7.40. While a mere 40 cents per share may not seem like a big difference, your $2,500 investment would only purchase 337 shares at the average price - a full 20 shares short of what you have accumulated through dollar cost averaging.
The key to this long-term investment strategy can be summed up in just one word: constant. You need to remember that you could still lose money if the investment you purchase declines in value, so dollar cost averaging is not a guarantee of profit.
However, it can keep you from investing all of your money at one time, perhaps at a higher price. To follow this strategy, you need to consider your ability - both financial and emotional - to stick with the program in both rising and falling markets.
Dollar cost averaging helps take the guesswork out of trying to time your investments, allowing you to focus on asset accumulation. As an additional benefit, because you buy more shares when the market is down, you'll be in a better position for potential gains if the market rebounds.
To find out whether this strategy would be appropriate, you need to evaluate your individual situation and your investment objectives. You may find, however, that this is just the right kind of plan to keep you on track and working toward your goals.
TIMOTHY McNAMARA is a financial adviser with Wells Fargo Advisors in Scranton. For more information, visit home.wellsfargoadvisors.com/timothy.mcnamara. Would you like to write for IN THIS CORNER? Contact us at business@times shamrock.com