Financial Quotient

What is dollar-cost averaging?

WHAT DOES IT MEAN?

Dollar-cost averaging is an investment strategy that involves committing a fixed amount of money at regular intervals to an investment, such as a mutual fund, regardless of price.

WHY IS IT IMPORTANT?

Through dollar-cost averaging, one may be able to invest more cheaply as a regular, fixed investment would mean buying more shares when prices are low and fewer shares when prices are high.

Historically, bull markets tend to outrun bear markets on aggregate, so over time, by virtue of owning more shares at a lower purchase price, the average cost per share may work out to be less than the average price per share in the long run.

Dollar-cost averaging can also minimise entry point risk, as investors need not be concerned about market fluctuations and determining when to get in or get out. From a behavioural perspective, this also provides discipline to emotional investors and reduces regret caused by mis-timing the market.

By following a strict investment plan, an investor may be less swayed by cognitive biases and emotions, such as anxiety associated with loss or overconfidence when there are gains. Overall, the investor is expected to make fewer irrational decisions. While there has been debate over the effectiveness of dollar-cost averaging, there are benefits to it. Of course, the caveat is that it neither assures a profit nor protects against losses.

IF YOU WANT TO USE THE TERM, JUST SAY:

"Dollar-cost averaging may be more suited for investors with a lower risk appetite, a long-term investment horizon, or those who may not be able to invest a lump sum."

A version of this article appeared in the print edition of The Sunday Times on February 25, 2018, with the headline 'What is dollar-cost averaging?'. Print Edition | Subscribe