This post will outline what a dollar-cost averaging (DCA) program is, the benefits of such a program and what type of investor it is best suited for, and finally how to implement such a program.
What is Dollar-cost averaging?
It is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price.
A simple example of this would be setting aside $100 every two weeks and investing it in a low cost index fund.
Is a DCA program right for you?
The first point worth making is that this technique is best suited for those who are investing in mutual funds (Including Index funds). This is because under such a program you will be investing relatively small amounts at a time, thus if you were investing in individual stocks the costs of each transaction would significantly eat away at any returns. However since their are typically no costs associated with investing in a mutual fund, this problem is nullified.
Besides being an effective way to ensure you set aside enough money to meet your investment needs, this technique has the added bonus of forcing you to buy more shares when the market is undervalued and less shares when the market is overvalued, thus enhancing your overall returns.
If you are a passive investor who is not interested in doing extensive market research, or if you lack the emotional stability to stay out of the market when it is overvalued and experiencing large gains and plunging your money in when it is experiencing large and consistent losses, then this approach is well suited for you.
In the words of the late, great, Benjamin Graham “systematic and uniform purchases of common stocks may present no more psychological and financial difficulties than similar continuos payments for United States savings bonds and for life insurance-to which they should be complementary. The monthly amount may be very small, but the results after 20 or more years can be impressive and important to the saver.” (i)
How can you implement this technique?
An easy way to take advantage of dollar cost averaging is by setting up a regular investment plan (RIP). A regular investment plan allows you to choose when and how often you make contributions; the money will be automatically withdrawn from your bank account an invested in the fund or common stock of your choosing.
(i) Graham, Benjamin. The intelligent investor: the definitive book on value investing. Pg. 118. New York: Harper, 2006. Print.