YOU MAY HAVE HEARD OF AN INVESTMENT STRATEGY called dollar-cost averaging and wondered, “What’s that?”  In reality, if you contribute a set amount of money to your retirement account every month, you’re already using dollar-cost averaging. It’s a strategy that has many benefits, especially during periods of volatility.

Simply put, dollar-cost averaging is the practice of investing a fixed amount of money at regular intervals, regardless of current market conditions. Over time, this consistent approach can help limit the effects of the market’s peaks and valleys, reduce the average price you pay for assets and improve your portfolio’s potential for long-term growth. 

4 reasons to consider dollar-cost averaging

1. It’s convenient. “One of the key benefits of dollar-cost averaging is that it makes investing a regular part of your financial life,” says Kirsten Cabacungan, an investment strategist with the Chief Investment Office (CIO) for Merrill and Bank of America Private Bank. With a plan in place to invest a certain amount regularly — whether it’s weekly, monthly or at some other interval — it takes the guesswork out of investing and makes it harder to forget to invest or to spend the money elsewhere.

2. It’s cost-effective. As share prices fluctuate, investing fixed amounts — whether in shares of an individual stock or an index or mutual fund — enables you to potentially buy more shares when prices are lower and fewer when prices are high. As the chart above illustrates, dollar-cost averaging not only creates portfolio momentum by potentially giving you more total shares of a stock or a fund; it can also potentially lower your average cost over time.  Of course, in the hypothetical example above, if Nick had invested the full $2,000 in April when the price hit a low for the year of $35 per share, instead of paying $40 in January he would have come out ahead. But since there’s no way to predict such swings, dollar-cost averaging removes the stress of trying to guess the best time to buy.

3. It can help you avoid costly mistakes during volatility. Sudden market shifts can prompt hasty decisions to sell when prices are falling. Having a disciplined schedule of investing regular amounts over time makes it more likely that you’ll stay in the market and focused on your long-term goals. “Volatility is a normal and even integral part of investing,” Cabacungan says. “Dollar-cost averaging could help you filter the noise and view periods of weakness as buying opportunities.”

4. It’s a constructive way to put more cash to work. Cash is essential for meeting expenses and emergencies without having to sell illiquid investments. “But maintaining too much of a cash cushion could rob you of the long-term growth potential that other investments like stocks can offer,” Cabacungan says. Your advisor can help you find a comfortable cadence and amount to invest that doesn’t conflict with your other financial needs.

Tips for getting started

While you can implement dollar-cost averaging by making regular investments on your own, an automated approach may be easier and more consistent. Just figure out how much you want to contribute, as well as the frequency — weekly, monthly or otherwise. Then arrange to have that amount transferred from your checking or other cash management account into an investment account – an IRA or brokerage account, for instance – and invested according to your preferred asset allocation. Fund transfers between institutions can generally be easily arranged. If you work with an advisor, they can help you set things up.

Keep in mind that for all its benefits, dollar-cost averaging is not a panacea. There’s no guarantee that you’ll achieve the returns you seek or prevent losses. Dollar-cost averaging is just a tool to help you put into action the important decisions you’ve made with an advisor about which assets to invest in, how to maintain a balanced portfolio and when to rebalance. “You don’t just set DCA and forget it,” Cabacungan advises. Over time you may want to adjust the amount you invest, as well as the frequency, just as you periodically review and adjust your asset allocation and the assets you invest in. 

For more information on the advantages of steady long-term investing, watch “Long-term investing: Core principles every investor should know.”