When you invest in a stock or a mutual fund, or any investment for that matter, you hope it increases in value over time. That’s certainly true of the money you invest in your company’s retirement plan. And while we’d love it if the stocks we bought today went up in value every day, it’s actually pretty rare for investments to go only up. Realistically, we should expect our investments to go up and down with the goal that they’ll increase in value over time.
So what does that mean when you’re investing for the long term in your retirement plan? Each payroll period, you set aside money to invest. When prices are higher, your money buys fewer shares. When prices fall, your money buys more shares.
Take this simple example: I have $100 to invest and I buy a fund at 25 dollars per unit or share. That means I buy 4 shares. If the price doesn’t change, I buy 4 more shares the next payroll period. Now I own 8 shares at a cost of $25 per share. Until the share price goes up, I haven’t made money on my investment.
But what happens if the on the next payroll period, the price is now $20 per share. This time my $100 buys 5 shares. So now I own 9 shares at an average cost of $22.50. That’s called “dollar cost averaging” because I’m buying more and averaging my cost. If the value goes back up to $25, I’m making money.
It’s very hard to time the markets and know exactly when to buy and when to sell. In your 401(k) account, you are dollar cost averaging since you’re buying at different prices -- both lower and higher as you invest each payroll period.
Dollar cost averaging is a way to invest for the long term without focusing on the top or bottom of the market. But remember, it’s a savings strategy and not a guarantee of a positive return.
If you would like more information on dollar cost averaging or would like to talk about your personal financial path, just give us a call. We’re here to help.