A risk of mutual funds is the fluctuating share price. Shares that were purchased on Monday for $9.50 may be selling for $9.35 on Tuesday or $9.58 on Thursday. These fluctuations occur because the prices of the securities in a fund will change based on activities in the markets.
Dollar-cost averaging is one way to help smooth out the effect of market fluctuation. It occurs when investors put the same amount of money into their account on a regular basis, usually monthly. Transferring money from a bank account each month to purchase mutual fund shares is a convenient way to do this.
The result of dollar-cost averaging is that more shares are purchased when the price is low and fewer shares are purchased when prices are high which should make the average cost per share lower than the average share price. Using this method, you can decrease the risk of making a lump sum purchase at an inopportune time. Dollar-cost averaging does not, however, assure a profit or protect against loss.
Hypothetical Illustration of Dollar-Cost Averaging
After investing for 12 months, using the example below, the average cost per share is lower than the average price and the current cost per share.
|Investment Date||Amount Invested||Share Price||# Shares Purchased|
Average Cost Per Share:
The chart above is intended to illustrate the mathematical principle of dollar cost averaging. This hypothetical example is for illustrative purposes only and doesn't represent any specific type of investment. It doesn't include the impact of expenses or fees, which would have reduced the results of the illustration.
How to Take Advantage of Dollar-Cost Averaging
There are many ways you can can take advantage of dollar-cost averaging. A common method is payroll deductions for an employer-sponsored retirement plan such as a 401(k) plan funded through mutual funds. You can decide on an amount to deduct from your paycheck on a monthly basis and shares will be purchased at that day's offering price. The principle of dollar-cost averaging also applies to after-tax accounts. If payroll deduction is not available, you may elect to have an amount automatically withdrawn regularly from your bank account through electronic funds transfer (EFT).
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