Dollars cost averaging is a practice used by investors who want to invest a certain amount of money per period instead of buying a certain number of shares per period. This is sometimes referred to as the constant dollar plan. While this investment strategy is appropriate for some people, it may not be for other people. Considering the benefits and pitfalls of this investment strategy and discussing it with your investment adviser can help you decide if this strategy is appropriate for your portfolio.

Benefits of Dollar Cost Averaging

You are making a commitment to invest money at regular intervals. Because of this, you will see your financial portfolio grow on a regular basis. The amount of shares you obtain will fluctuate depending on the stock market. However, it is unlikely that you will lose everything unless there is another stock market crash, according to Paul S. Marshall’s “A Statistical Comparison of Value Averaging vs. Dollar Cost Averaging and Random Investing Techniques,” which was published in the Journal of Financial and Strategic Decisions.

The benefit is that your will obtain shares at an “average” price, ensuring you are not buying all of the shares at the peak price.

Pitfalls of Dollar Cost Averaging

By making consistent periodic transactions instead of making less-frequent lump sum transactions, you may end up paying more money in transaction fees. For example, if your investment firm charges $10 per transaction and you make one $100 investment per month, you will pay $120 in transaction fees for the year. However, if you place that $100 per month in an interest bearing savings account and invest the entire $1,200 at the end of the year, you will only pay $10 in transaction fees. That is a saving of $110, which is enough to fund your first payment for the following year.

The other pitfall is that your potential return on investment is less, since by definition you will buy some shares at a high price and some at a low price.

Other Considerations

There is a chance that you will end up paying less per share of stock when you use the dollar cost averaging method of investing. If you are only looking for short-term investments, then this may not be appropriate for you, as you stand to lose a lot of money if you end up buying your stocks while they are on the higher side of the market average. Dollar cost averaging is likely a good choice if you are saving for retirement. This allows you to buy stocks while they are on both the lower end of the market average and the higher end, but you will end up with more shares that you can sell when the price-per-share is at a high point.