Definition: An investing approach where, instead of investing all of your money at one time, you invest a portion of it every so often, such as once per month.
Example: You save up a bunch of money working summer jobs and want to invest $2,500 of it in Nike. Instead of buying $2,500 of Nike stock today, you buy $500 of Nike stock on the first day of each month for the next 5 months. You will eventually own $2,500 of Nike’s stock, but you will build your position over time.
Investeach explains: Who says when you decide to make an investment in a company that you have to “throw down” on it all at once? By dollar cost averaging, you dramatically reduce market risk and timing risk.
Curiously, as you follow this approach, you don’t mind dips in the stock price. In fact, you may actually root for them. When the price is down, you get more shares when you make your next periodic investment!
Finally, most adults practice this technique out of necessity. They don’t have a pile of money sitting around waiting to be invested. Instead, they work hard at their jobs and are able to use a portion of what they earn each month to add to their investments.
Riddle me this:
1. Which two investing risk does dollar cost averaging dramatically reduce?
2. Why might an investor actually root for the stock of a company he owns shares in to temporarily fall?
3. Why don’t most adults have a choice about whether or not they dollar cost average?
Related terms: Market risk, Timing risk.