Planning retirement: dollar-cost averaging
The stock market is unpredictable, making investing a tricky endeavor. You can get around some of the uncertainty by using dollar-cost averaging when investing.
What is dollar-cost averaging?
Dollar-cost averaging is investing a particular amount of money on a regular schedule over the long term, regardless of how the market is doing. Your shares are cheap in a down market and more expensive in an up market. When planning retirement, this is a useful tool that can help you meet your retirement goals.
How it works
Let’s say that you plan to invest $100 a month for three months. The first month shares of ABC fund cost $10 each, so you get 10 shares. Then shares double the second month to $20 per share, so you get five shares. The third month shares are at $25, so you get four shares. At the end of three months, you have 19 shares for a total investment of $300. Because shares are now trading at $25, you have a profit of $175, a figure arrived at by multiplying 19 by $25 and subtracting your $300 investment. Your average cost for fund shares was about $16.
Of course, in reality, fund shares are not likely to rise that quickly in such a short time span. But as you can see, dollar-cost averaging typically nets more reliable yields than you would see if you dropped a lot of money in the market all at once. With a lump sum, you could lose a large portion of your money if the market headed south shortly after you invested.
Where to use it
Dollar-cost averaging is commonly used among those who are planning retirement by investing regularly in tax-favorable retirement vehicles. One example of this would be to have money directed from a savings account to an IRA each month. The same is true with a company retirement plan. Generally, you can elect to have a set amount automatically deducted from your paycheck and contributed to funds in your 401(k) plan.
Check out Bankrate’s retirement calculators and tools for help with planning.