1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion

The concept of buying at a market low and selling at a high point is straightforward; it ensures maximum profit. However, timing out the fluctuations of the broader market or an individual stock turns out to be incredibly tricky. Even experienced and professional investors have a difficult time picking bottoms and tops in the market. This is one reason why many investors turn to dollar cost averaging (DCA).

Don’t let the terminology fool you; DCA is actually a simple and useful strategy for investing. Dollar cost averaging refers to the process of buying (irrespective of share price) a fixed dollar amount of a particular investment on a periodic, regular schedule. Because the dollar amount does not change, this results in fewer shares being purchased when prices are high, and more shares purchased when prices are low. Over time, the cost per share tends to average out. Through this process, an investor reduces his or her risk of investing a large amount in a single investment at the wrong time.

Here’s an example to help illustrate DCA. You receive an inheritance which leaves you with $10,000 to invest. Instead of taking that lump sum and investing it in a mutual fund or a stock all at once, DCA would suggest that you spread the investment out across several months. You might decide to invest $2,000 per month for the next five months, and this would then “average” the price of the security you invest in over that time period. For one particular month, you might buy while the stock is priced high, and the next month you might get more shares because the price is lower, for example.

DCA is a strategy that also benefits investors who don’t begin the investment process with a significant sum of money to invest. If you are able to invest smaller amounts regularly, you can ensure that you take advantage of growth over the long term. DCA is not perfect, however. Dollar cost averaging can’t prevent a loss in a market which is suffering from steady declines. Still, over the long term, this strategy tends to be an effective one.

Financial Concepts: Asset Allocation
Related Articles
  1. Trading

    Choosing Between Dollar-Cost And Value Averaging

    These are two investing practices that seek to counter our natural inclination toward market timing by canceling out some of the risk.
  2. Trading

    Take Advantage Of Dollar-Cost Averaging

    We explain how dollar-cost averaging offers protection and opportunity in a sinking market.
  3. Financial Advisor

    5 Questions First Time Investors Should Ask in 2016

    Learn five of the most important questions you need to ask if you are a new investor planning on starting an investment program in 2016.
  4. Investing

    Investing $100 a Month in Stocks for 20 Years

    Learn how a monthly investment of just $100 can help build a future nest egg using properly diversified stocks or stock mutual funds.
  5. Investing

    Ten Worst Mistakes Beginner Investors Make

    Here are the ten worst mistakes beginning investors make.
  6. Investing

    The Benefits of Picking Mutual Funds Over Individual Stocks

    Learn about the advantages of investing in mutual funds rather than individual stocks, including the benefits of affordability, oversight and diversification.
  7. Investing

    Investing With a Purpose

    Your reasons for investing are bound to change as you go through the ups and downs of life.
  8. Financial Advisor

    How to Know When to Pass on an Investment

    Knowing what to invest in is important, but knowing what not to invest in is equally important. Here's how to decide when to walk away.
  9. Investing

    How to Invest Money With a Broker

    The basic principle of investing is simple: buying something today that you think will be worth more in the future.
Frequently Asked Questions
  1. Can coupon in fixed-income security effect bond yield maturity?

    See how fixed-income security investors can expect to use coupon on semi-annual payments if the bond or debt instrument is ...
  2. How are savings bonds taxed?

    Learn who is responsible for reporting U.S. EE savings bond interest for taxation and when the interest can be reported for ...
  3. What is the difference between inflation and deflation?

    Determine how inflation and deflation affect prices, employment, loans, and the central banks. Economies frequently teeter ...
  4. How does the foreign-exchange market trade 24 hours a day?

    Trading in the forex is not done at one central location, but is conducted by phone and electronic communication networks ...
Trading Center