Consider Dollar Cost Averaging to Reduce Market Risks

Dollar billIt’s no secret that in volatile times like these, investors can easily lose sight of their long-term financial goals or even fall into the trap of trying to time the ups and downs of the market. But keep in mind that in order to be a successful market timer, you need to get it right twice – once when you sell and again when you buy. This is extremely difficult even for life-long investment professionals. At the same time, taking your money out of the market and sitting on the sidelines in times of volatility may cause you to miss out on market rebounds and bull markets when they occur.

To avoid the stress and traps of market timing, developing a disciplined investment plan through dollar cost averaging can help remove the emotion created by market volatility and help reduce market risk. With this approach, you buy a fixed dollar amount of shares on a regularly scheduled basis, regardless of the share price. Here’s an example:

You decide to spend $100 on a specific stock every month for three months. In January, the stock is worth $33, so you buy three shares. In February, it’s worth $25 so you get four additional shares. Come March, the stock is selling at $20 so your $100 gets you five more shares. By this time, you’ve bought 12 shares in total, for an average price of approximately $25 each.

Many investors are already practicing dollar cost averaging without realizing it. Employees who regularly invest in their 401k, 403b or other individual retirement accounts via payroll deductions are practicing dollar cost averaging through regular contributions to their plans. For those investors looking to implement a dollar cost averaging investment strategy, here’s how you can get started:

  • First, determine how much money you can invest each on a regular basis whether it’s once every paycheck or every month
  • Next, choose an investment option that is appropriate for your risk tolerance and stick with the plan for long term to try to achieve your retirement goals.
  • Finally, stick to investing the same amount every time in your investment portfolio (for example every paycheck, monthly or quarterly), otherwise the plan may not be as effective. You may also consider setting up an automatic or systematic withdrawal plan so the process becomes automated.

We realize that many investors may not have large amounts of cash on hand to invest in the market all at once. Perhaps that is why the combination of having an investment strategy like dollar cost averaging and a well-thought-out financial plan can help keep you on course when the markets are in their most volatile period. In addition, your financial plan should be designed to provide a clear roadmap for achieving your goals. A financial advisor can assist with your financial plan and investment strategy.

Remember, dollar cost averaging can allow for disciplined buying in times when it’s toughest – and ultimately allows you to buy more shares when prices are low and fewer when prices are high. Creating the proper investment strategy, rebalancing it periodically and staying on track to meet your financial goals may increase your chances of success.

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