What you need to know about the dollar cost averaging investment strategy

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If you’re already contributing money to a 401(k) retirement account, you may not have realized it, but you’re practicing a popular investing strategy known as cost averaging.

In simple terms, this approach means that you invest fixed, equal amounts on a regular basis, say monthly or every two weeks, rather than investing a single amount of money all at once.

With a 401(k) defined contribution plan, for example, you invest as you earn, regularly taking money from each paycheck throughout the year and putting it into the market. The cost average could also look like if you decided to invest $5,000 of your savings by dividing that money into five parts, where $1,000 is invested each month for five months.

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Here’s what you need to know about the average purchase price

Averaging allows you to spread out your investments and buy in the market at different times at varying prices. In turn, these purchase prices ideally balance out, hence the “average” part of the phrase.

Experts often recommend this long-term investment approach (particularly with broad market tracking index funds) to people with a low appetite for risk, as providing liquidity consistently over time reduces risk. impact of any market volatility on an investment. Not to mention that this allows investors to forget about the up and down movements of the market since their contributions are not influenced by what is happening; they pay dues at regular intervals no matter what. It helps to leave out emotion-based investments.

Recurring purchases by fixed sums vs lump sum investments

Cost averaging is often compared to its antithesis, lump sum investing, an opposite approach otherwise known as simply timing the market.

Like dollar cost averaging, lump sum investing can also help you build wealth and, even better, maximize your returns, but with the caveat that you take on a lot more risk. After all, as we all know, no one can really time the market.

When you invest a large amount of money in the market all at once, your money is immediately put to use. With cost averaging, however, only part of your money goes into the market to begin with and the rest is set aside for future contributions – this might allow you to catch up to future market declines, but your immediate gains may be lower if the market takes off earlier than expected.

Is the purchase average right for you?

When investing with a method or strategy, the first step is to identify the potential returns as well as your risk tolerance.

While you can get better returns over time with a lump sum investment, it’s not a good idea for those looking to reduce their short-term downside risk, as the potential for loss is greater.

Risk-averse investors, or those who are concerned about market volatility, are better off using the dollar cost averaging approach to investing. A good place to start is an S&P 500 index fund that has posted an average annualized return of around 10% since 1957.

For example, Charles Schwab’s S&P 500 index fund is a simple option with no minimum investment. Its expense ratio is 0.02%, which means that every $10,000 invested costs $2 per year. Index funds typically have an expense ratio of 0.2%, which is particularly low.

Charles Schwab

  • Minimum deposit and balance

    Deposit and minimum balance requirements may vary depending on the investment vehicle selected. No account minimum for active investing via Schwab One® Brokerage account. Automated investing with Schwab smart portfolios® requires a minimum deposit of $5,000

  • Costs

    Fees may vary depending on the investment vehicle selected. Schwab a® The brokerage account has no account fees, $0 commission fees for stock and ETF trades, $0 transaction fees for 4,000+ mutual funds, and $0.65 fees by option contract

  • Prime

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    Robo-advisor: Schwab Smart Wallets® and Schwab Intelligent Portfolios Premium™ IRA: Charles Schwab Traditional, Roth, Rollover, Legacy and Custodial IRAs; plus, a Personal Choice Retirement Account® (ECRP) Brokerage and negotiation: Schwab a® Brokerage account, brokerage account + specialized platforms and support for trading, Schwab Global Account™ and Schwab Organization Account

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    Stocks, bonds, mutual funds, CDs and ETFs

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    Complete retirement planning tools

For an option with no spend ratio, consider the Fidelity ZERO® Large cap index fund. While the fund doesn’t technically track the S&P 500, the Fidelity US Large Cap Index tracks large-cap stocks, which the website says “are considered the stocks of the 500 largest US companies.”

Loyalty investments

  • Minimum deposit and balance

    Deposit and minimum balance requirements may vary depending on the investment vehicle selected. No minimum to open a Fidelity Go account, but a minimum balance of $10 for the robo-advisor to start investing. Minimum balance of $25,000 for personalized planning and advice from Fidelity

  • Costs

    Fees may vary depending on the investment vehicle selected. No commission fees for trades in stocks, ETFs, options and some mutual funds; zero transaction fees for over 3,400 mutual funds; $0.65 per options contract. Fidelity Go is free for balances under $10,000 (afterwards, $3 per month for balances between $10,000 and $49,999; 0.35% for balances over $50,000). Fidelity’s personalized planning and advice has a 0.50% advisory fee.

  • Prime

  • Investment vehicles

    Robo-advisor: Fidelity Go® and Fidelity® Personalized planning and advice IRA: Fidelity Investments Traditional IRAs, Roths and Rollovers Brokerage and negotiation: Fidelity investment trading Other: Fidelity Investments 529 Education savings; Loyalty HSA®

  • Investment opportunities

    Stocks, bonds, ETFs, mutual funds, CDs, options and fractional shares

  • Educational resources

    Comprehensive tools and industry-leading in-depth research from over 20 independent vendors

You can also consider investing a fixed monthly amount through a robo-advisor like Betterment, which will create a personalized portfolio of ETFs (which are similar to index funds) for you based on your risk tolerance and of your investment horizon.

Improvement

On Betterment’s secure site

  • Minimum deposit and balance

    Deposit and minimum balance requirements may vary depending on the investment vehicle selected. For Betterment Digital Investing, minimum balance of 0 USD; Premium investment requires a minimum balance of $100,000

  • Costs

    Fees may vary depending on the investment vehicle selected. For Betterment Digital Investing, 0.25% of your fund balance as an annual account fee; Premium Investing has an annual fee of 0.40%

  • Prime

    Up to one year of free management service with qualifying deposit within 45 days of signup. Valid only for new individual investment accounts with Betterment LLC

  • Investment vehicles

  • Investment opportunities

    Stocks, bonds, ETFs and cash

  • Educational resources

    Betterment RetireGuide™ helps users plan for retirement

Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.

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