Investing the same dollar amount every month of the year in the same stock or mutual fund—or dollar-cost averaging—is the single best way to minimize your risk of buying shares at the wrong time. And if you're thinking of investing in the current market environment, when some stock prices are down by as much as 70 percent from their highs, this is the optimum time to use dollar-cost averaging.
Why? Let's say you have $12,000 to invest this year and you have picked a mutual fund to put it in. Shares of this fund have gone as high as $15 but have fallen to $10. Now's your time, you think, and you invest all $12,000 in 1,200 shares. Oops! You were wrong. A temporary setback drives the share price even lower, and a year later shares are selling for $5. On paper you've lost $5 a share, for a total loss of $6,000; what's more, you have no money to buy more shares at the lower price (when they may be a real bargain).
If you take the same $12,000 and invest it in the mutual fund in stages, at the rate of $1,000 a month over a year, here's how you'll come out: After one year, you own a total of 1,717 shares, worth $8,585 at $5 a share. Even though the price per share is down to $5, your loss on paper is only $3,415, or $2,585 less than if you had bought the fund outright. You also own 517 more shares to profit from should the price go back up. When it's at $10 again, you'll have 1,717 shares, worth $17,170, instead of the $12,000 you'd have if you had bought them all at once. (By the way, if you contribute to an IRA or a 401(k) every month, you're already using the principles of dollar-cost averaging.) This method, like all recommended strategies for investing in the stock market, depends on your having at least ten years before you need the money you invest.