Investing inherently involves some risk; that’s just the way life works. Our job as investors is to figure out ways in which to minimize this risk. One common method that investors use to minimize risk is dollar cost averaging.
Dollar cost averaging involves investing a fixed amount over a predetermined period of time rather than all at once. The rationale behind dollar cost averaging comes from the idea that markets don’t move in a straight line. By investing the same amount, you end up buying fewer shares when the price is high and more when the price is low. Not only that, but it minimizes risk from big market shifts during the entire investment period. If something should go terribly awry with the company you’re investing in, you can always simply stop purchasing shares and less of your investing capital will be affected.
Another benefit to dollar cost averaging is that is helps overcome decision paralysis. It’s natural to be hesitant before investing a large amount of your hard earned money, even in the bluest of blue-chip stocks. However (and especially for new and inexperienced investors), gradually easing in to the market makes it easier to invest. Further, with the recent market volatility, gradually investing over a period of time helps to remove the uncertainty of the timing of your investing, so you are not constantly trying to find the lowest price. A gradual, steady approach enables you to begin and continue the investing process in an effort to reach your long-term goals.
While dollar cost averaging may be the best idea for novice investors, it by no mean guarantees a return on investment. In addition, new research suggests that lump sum investing may pay off in the long run. However, dollar cost averaging is far less nerve-racking and helps many investors sleep more soundly at night.