What Is Dollar-Cost Averaging?

What Is Dollar-Cost Averaging?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Dollar-Cost Averaging is a strategy used in investment where an individual decides to divide up the total amount to be invested across periodic purchases of a target asset. The aim is to reduce the impact of volatility on the overall purchase. This strategy helps to remove much of the detailed work of attempting to time the market to make purchases of equities at the best prices.

Related Questions

1. How does Dollar-Cost Averaging work?

Dollar-Cost Averaging works by investing a fixed amount in an asset on a regular schedule, regardless of the asset’s price. Over time, this strategy results in purchasing more shares when prices are low and fewer when prices are high, potentially lowering the total average cost per share of the investment.

2. When is the best time to use Dollar-Cost Averaging?

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Dollar-Cost Averaging is particularly useful in volatile markets. This is because it helps to eliminate the risk of making a large investment just before a market downturn. Therefore, it works as a risk reduction strategy.

3. Does Dollar-Cost Averaging guarantee profit?

No, Dollar-Cost Averaging does not guarantee you’ll turn a profit. It merely reduces the risk of suffering considerable losses from purchasing an asset at its peak price. It simplifies investment by automating it and dispersing risk over a length of time.

4. What are the drawbacks of Dollar-Cost Averaging?

One potential downside of Dollar-Cost Averaging is that it can be less beneficial in a consistently rising market. If the market is rising, you end up buying shares at an increasingly higher price. However, the method is meant for lowering risk rather than guaranteeing gains.

5. Can Dollar-Cost Averaging be used with any kind of investment?

Yes, the principle of Dollar-Cost Averaging applies to a variety of investments that can fluctuate in value, including mutual funds, ETFs, and individual stocks. It’s often used with long-term investments.