Dollar Cost Averaging When Buying Mutual Funds

One of the most difficult investment decisions is "when to buy." Even if you are convinced you have made a good mutual fund choice, there is still the question of whether now is the right time to buy or you should wait for the price to fall. Having difficulty answering the "when decision" can be one of the most frustrating parts of investing. You want to make the investment, but you have a fear that as soon as you buy, the price will drop and your investment will lose some of its value.

One way to make sure you do not buy at the top of the market is to use a strategy called "dollar cost averaging." This involves making equal dollar purchases of a mutual fund on a regular basis. By investing a set amount periodically, you will buy fewer shares when prices are high and more shares when prices are low. The net result is that your average cost ends up being below the average price for the investment period.

Many mutual funds have even established programs where they will electronically transfer money from your checking or savings account on a regular basis to facilitate this strategy of dollar cost averaging.

Using the dollar cost averaging strategy to buy mutual funds can take a little longer to get fully invested. If the market goes up continually, you will miss some appreciation. However, markets seldom go straight up or straight down. Using dollar cost averaging prevents you from investing all your funds at the top of the market.

Here is an example to demonstrate how this strategy works. Let us assume you have $10,000 you want to invest in fund XYZ. Using dollar cost averaging over a 10-month period would result in the following:

Using the dollar cost averaging strategy, the average cost of the mutual fund shares was $9.90 and the value of the shares at the end of the period was $10,103. Buying all the shares in the first month would have resulting in a share price of $10 and a value after 10 months of $10,000. If the shares had gone up continually over the period, clearly it would have been better to have purchased all the shares at the beginning.

In this example, using dollar cost averaging increased the value by $103 or about 1%. While the increased return is not large, an increase of 1% is important. Using dollar cost averaging also provides the peace of mind that you will not invest all your funds at a market peak.