Investing in dribs and drabs may not be the path to greater return, but we still think dollar-cost averaging, or investing a set amount on a regular basis, is a great method of investing. Incidentally, if you contribute to a 401(k) plan at work, you're already investing this way. Our argument for dollar-cost averaging has a couple of dimensions. First, dollar-cost averaging can reduce risk. If your mutual fund declines in value, the worth of your investment is less, even though you still own the same number of shares. In the same way that dollar-cost averaging will net you more shares in a declining market, it can curtail your losses as the fund goes down. The chart below illustrates this point.
| Fund Value Decreases|
|Your Friend's |
5,556 shares at
$1.80 per share
|1,111 shares at $1.80 per share|
||1,250 shares at $1.60 per share|
||1,379 shares at $1.45 per share|
||1,538 shares at $1.30 per share|
||1,667 shares at $1.20 per share |
In this example, both you and your friend lost money (remember, you each started with $10,000), but your friend lost less by dollar-cost averaging. She had cash sitting on the sidelines that did not lose value. And when the fund rebounds, your friend also will be in better shape because she owns more shares of the fund than you do.
The second reason we like dollar-cost averaging is that it instills discipline. Investors often chase past returns, buying funds after a hot performance streak. And they'll sell funds when returns slow or decline. Bad idea: That's a form of market-timing. But dollar-cost averaging prevents you from market-timing, because you're buying all the time. Heck, you may even forget that you're investing if you set up an automatic-investment plan with a mutual fund family.
Which leads us to the final reason we love dollar-cost averaging: It's a crafty way to invest in some great mutual funds that might be inaccessible otherwise. Many fund companies will waive their minimum initial investment requirement if you agree to set up an automatic-investment plan and invest a little each month or quarter.
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