When it comes to investing, you may fall into one of two camps: You may find it exciting, or maybe you find it too stressful. If the former, perhaps you’re inclined to put your money in the market all at once and stand back, hoping you’ve timed it right. If you’re in the latter group, keeping your attention on a shifting market might give you the jitters, keeping you from investing at all.
Neither of these situations is ideal and it’s usually better to consistently invest your money over time, a strategy known as dollar-cost averaging, which typically involves investing a fixed dollar amount on a monthly or bi-weekly basis. If you have a 401(k) account, you’re already practicing dollar-cost averaging, as your contributions are automatically invested every pay period.
It’s hard, if not impossible, to predict what’s going to happen in the market and identify the ideal time to buy shares. In fact, doing so can lead you to make costly mistakes. By investing at regular intervals, you’re bound to sometimes buy when prices are higher and sometimes when they’re lower. That’s OK. The set dollar amount you’re investing buys fewer shares when prices are up and more shares when they’re down, ultimately reducing the average cost of your shares.
You also don’t have to worry about the timing of your investment. Over time, the market’s peaks and valleys average out. And the gains on shares purchased when prices are low can make up for the shares you paid more for when prices were high.
This method also ensures that on at least some of the days you’re investing, the market will be down – a time when some investors are selling out of fear and others might be afraid to buy. For patient investors, down markets are good buying opportunities. After a downturn, the market eventually tends to go up, so buying at those moments when prices are low can help secure gains in the long run.
A long-term strategy
Regardless of the sum you have to invest, dollar-cost averaging is a long-term strategy. While the financial markets are in a constant state of flux, over long periods of time, most stocks tend to move in the same general direction, swept along by larger currents in the economy. A bear market or a bull market can last for months or even years. That reduces the value of the dollar-cost averaging as a short-term strategy.
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