Dollar-Cost Averaging: Great for Crisis Investing
Dollar-cost averaging is an investment strategy to build savings over the long term. So, if you are worried about money for retirement, this may be something to consider. Not everyone has money to spare in tough times to put into a 401(k) account, but if you do, you can reap great rewards by staying with the program.
Here's how it works: Let's say you've committed to investing $100 a week in your 401(k) plan, in the XYZ Fund. Shares have been $25 each, so every week, you purchase four shares. However, one week, the shares fall to $20. So your $100 buys five shares that week. Ideally, the fund recovers, and you find yourself with five shares now worth $25 each. In that case, this was a better strategy than just making a commitment to buying a certain number of shares, regardless of the price. As Investopedia puts it, "Dollar-cost averaging aims to avoid making the mistake of making one lump-sum investment that is poorly timed with regard to asset pricing."
Of course, using this investment method cannot protect you against the risk of declining market prices, but it can help flatten volatility. At any given moment, most shares will have been purchased at a lower price, and the general concept is that prices will eventually always rise. Although this method works with mutual funds and individual stocks, most retirement investors are better off with the former. If you bought a stock without knowing the company's details and used dollar-cost averaging, you might find yourself pouring money into a continually falling investment.
Dollar-cost averaging can be used in any kind of investment plan, but is especially suited to 401(k) investing, which automatically takes the same amount out of your paycheck each month, despite the state of the market. This strategy removes the detailed work of timing the market to make equity purchases.
In summary, keep in mind the three great advantages of dollar-cost averaging in a 401(k) plan:
- Your investment grows more quickly as the stock's price goes up.
- You eliminate the risk of mistiming the market and at a minimal cost.
- You'll never be able to consistently predict where the market is heading anyway, so this relieves the pressure.
Finally, remember that investing doesn't exist in a vacuum. If you're facing economic insecurity now because of current or incipient job loss, don't stretch yourself too thin by putting money you can't afford to lose in the market right now, whether inside or outside a 401(k) plan. You also have to consider how close you are to retirement. But if you're stable and still have some years of productive employment ahead, don't give up your 401(k) investment plan because of a down market. Dollar-cost averaging can make this the best time ever.