If you’ve followed the stock market lately, you know that
volatility is the rule, not the exception. With stocks taking such
wild swings, how can an investor know when to buy?
The answer for many is a simple strategy known as dollar-cost
averaging. The idea is this: You systematically purchase the same
dollar amount of an investment each payroll period or each month.
By using this approach, the price you pay for an investment
averages out over time, allowing you to concentrate on long-term
wealth accumulation.
If you’ve followed the stock market lately, you know that volatility is the rule, not the exception. With stocks taking such wild swings, how can an investor know when to buy?
The answer for many is a simple strategy known as dollar-cost averaging. The idea is this: You systematically purchase the same dollar amount of an investment each payroll period or each month. By using this approach, the price you pay for an investment averages out over time, allowing you to concentrate on long-term wealth accumulation.
For example, let’s say you set up a plan to invest $100 a month in a stock index fund. In the first month, the share price is $50, so you buy two shares. Next month the share price drops to $40. Now your $100 will purchase 2.5 shares. The following month the share price climbs to $60, so your $100 buys only 1.6 shares. You purchase more shares when the stock price falls, fewer when it climbs. Studies show that this strategy enables you to purchase more shares at lower prices than if you had tried to time the market.
Some cautions are also in order. For one thing, you still have to buy fundamentally sound investments. In addition, a diversified portfolio remains important. (Stock index mutual funds offer a good choice for many people.) Also, dollar-cost averaging requires discipline.
That’s why automatic payroll deductions or fund transfers often help investors to remain focused for the long term.
For the average investor, who may have neither the time nor the expertise to follow the market closely, dollar-cost averaging can be a simple and effective way to save for the future.
Barbara Andres is a CPA and a partner with the accounting and business consulting firm of Bianchi, Lorincz & Company located in downtown Hollister.
