Dollar cost averaging takes the fear out of investing.  Today we’ll explain what it is and how it benefits you whether you have $5 to start with or $1000.

Do you have some money that you want to invest, but you’re waiting until the exact right time to invest it? You don’t just want to dump a pile, especially a big pile of money into the market at the wrong time and watch it evaporate. There are two ways you can avoid that happening; one is the wrong way, and one is the right way.

All investors have two major concerns when they invest, making money and limiting risk. We all want big profits fast with no risk. But that’s not the reality of investing. To make money while limiting risk, we have to employ a good investing strategy. Dollar cost averaging is just such a strategy; it’s good for all investors but especially for those new to investing.

A Very Bad Day

On September 29, 2008, the Dow Jones Industrial Average suffered one of the worst losses in Wall Street history. Upon the news that the House had rejected the $700 billion bank bailout plan, the Dow plunged 778 points. In an instant, $1.2 trillion dollars in market value evaporated. If you had been a wary investor but finally decided to take the plunge on that day, you would have had a very bad day indeed.

A Very Good Day

Just two weeks later, Wall Street saw its biggest one-day gain in history. The Dow added 936 points, and a record $1.2 trillion dollars surged back into the market. If you had invested that morning, you would have had a very good day indeed.

Timing the Market

If you had known to pull your money out before that big crash and known to put it back in the day of the big gain, you would have timed the market perfectly. But how would you know the crash and the rebound were coming? Some people think they can predict such things by timing the market.

Timing the market means trying to predict the direction of the market by analyzing market and economic data. It’s a good idea in theory because like we explained above, you would hate to invest your money right before a big drop in the market and love to invest it before a big gain.

So if you’ve done a bit of research, you might decide that timing the market is the best strategy. Do you have a Magic Eight Ball? Because if you do, give it a shake and ask it when you should invest. That will give you about as good a result as trying to time the market will.

Professional fund managers can’t time the market with much success and not only do they have reams more data than you have, but they also have the time to pour over all of it and to understand what that data is telling them. And they still do worse than the market more than 80% of the time!

Even if you did have the time and understanding to go over all that data, why would you want to? It’s boring! This is the wrong way to go about dumping money into the market if you want to protect yourself from unnecessary risk. But there is a way to do that.

What is Dollar Cost Averaging?

The term dollar cost averaging sounds more complicated than it is. It simply means that you determine a set dollar amount that you want to invest and invest that amount on a set schedule without regard to the share price.

Here’s an example; you have $1000 you want to invest. You invest $100 a month over the course of ten months. Using this method, you will average out the cost per share so that you don’t have to worry about timing the market.

Now let’s look at a more specific example; our goal is to get as many shares possible for the lowest price without making life too complicated. You have $500 to invest in Nike. The first month each share is $50, so you buy two. The second month each share is $40, so you buy two and a half.