Defensive Investing: Use Dollar-Cost Averaging to Reduce Volatility Risks
August 11, 2010 at 06:00 AM EDT
Dollar-cost averaging has long been a strategic staple among mutual fund buyers. Longer-term investors use it to smooth out the effects of short-term price fluctuations, but the tactic seldom has been practical for purchasers of individual stocks - that is until now. For those unfamiliar with the strategy, dollar-cost averaging - also known as constant-dollar investing - involves the regular purchase of a smaller fixed-dollar amount worth of shares over time, as opposed to the lump-sum purchase of a large number of shares at once. For example, rather than buy $1,200 worth of shares of fictitious company XYZ in January, you might buy $100 worth of XYZ shares each month for the full year. The technique offers several advantages for fund investors: Because you are investing a fixed-dollar amount at regular intervals, you don't have to be concerned with trying to time the markets. Since the fixed-dollar amount you invest buys more shares when prices are low and fewer when they are high, your average cost basis levels out over time. This reduces the risk that you might pay too high a price by making a lump-sum purchase at the wrong time. The lower average cost basis mutes the impact of short-term volatility on your existing holdings. You can build a sizable position in a single fund, even if you never have a large sum of money to invest at any one time.