How To Use Dollar Cost Averaging To Build Wealth

Tired of cinching that proverbial belt ever tighter? The last two years have been all about cutting expenses and doing without, haven’t they? Well I say – maybe it’s time to shift from cutting out the lattes to getting a cut of the coffee profits.

If you are ready to take advantage of your new saving habits, there is a tried and true way to do this: Dollar Cost Averaging. It isn’t new and exciting, but many a millionaire next door has proven its success. The best part – you don’t need a big stash of cash to get started.

Dollar Cost Averaging (DCA)

The principal behind dollar cost averaging is this: You put the same amount of money into the same investment on the same day each month. Those months when the investments’ price is going up, your set amount might not buy very many shares. But when the investment’s price dips (as they all do from time to time), you get to buy more shares at a cheaper price. Guess what? When the price goes back up, all those shares you bought cheaply will have made you some money. Those shares you bought when the price was high will look good, too.

There are a few reasons to invest this way:

1. It takes the guesswork out of trying to predict what the stock market is going to do (aka timing the market). As long as you feel good about this company, you DON’T CARE what the stock market is doing day to day. In fact, you are celebrating when the market is down on your investment day, because you are getting to buy more shares of a company you think has great long term prospects. And you are celebrating again when the market is rallying because all your shares are more highly valued. Isn’t that great?

2. It creates a disciplined approach to building wealth. You are now on a path to save and invest regularly, building wealth one month at a time. Yes, we have all read about those hot stocks that made someone rich overnight. But for most of us, it’s going to take a working lifetime to accumulate our wealth.

3. You can do this for as little as $100 per month. In fact some mutual fund companies, like T Rowe Price, will set up a DCA for as low as $50 per month. You don’t need thousands of dollars to get started or to continue your dollar cost averaging plan. So, no excuses!

Some Do’s:

1. Do Your Research. Make sure you are picking a stock or mutual fund (yes, you can DCA into either one) that you feel has strong long term growth potential. Go to your local library – they will often have a ValueLine subscription. Or get an online subscription to Morningstar. If you already have a brokerage account, find out which stocks or mutual funds they offer for DCA – they can also provide you with their own research opinions.

2. Start with a monthly amount that won’t break your bank. This is money you won’t miss on a monthly basis. Ask your broker or mutual fund company for their minimum DCA amount. Don’t have an investment account yet? Check out ING’s Sharebuilder to get started with an online account.

3. Do work up to a DCA approach into multiple stocks across industries. If you are doing a DCA into a mutual fund you will have some diversification built in, but if you are buying an individual stock, you want to eventually own five or more to reduce your dependence on one performer.

4. Commit to a DCA program of AT LEAST 12 months. It takes time to build wealth and see the results of your efforts.

Some Don’ts:

1. Don’t wait for the price to go up or down, nor vary the amount based on how much is in your savings account that day. Set it up for the same day, same amount, same stock – good times and bad.

2. Don’t stop it when the market takes a nose dive. If you still believe in the individual company, keep investing. Remember, in a down market you are buying more shares, cheaply.

There are some market pundits who say Dollar Cost Averaging is dead. They will show charts and graphs proving that if you had done a DCA over a certain period of time instead of putting a lump sum into the market on a certain day you would now have less money. And they would be right. But you know what they say about hindsight….Who knew that was THE day to invest in the market?

This approach is about BUILDING wealth. Steadily, consistently, with discipline over time. It’s about creating and strengthening good money behaviors. When you’ve done this for ten years and see your accumulated balance, you won’t care that you missed the best day in the market in 2011.

Already a DCA investor? Let me know how it’s worked for you!

About the author

Lea Ann Knight, CFP®

Lea Ann is the Principal of Garrison/Knight Financial Planning as well as the creator of the financial literacy site, Financially Fit After 40. She also writes a monthly column as the Money Expert for All You Magazine.

One Comment

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  • i am dollar cost averaging and i tell you at the end of every year i am suprised at the units i have addeded in my portfolio its perfect when you have the disciplne and patience as ben graham said make the market your friend if she gives you rock bottom prices on great issues grab and hold

    i am convinced will retire sooner than most on this strategy!!!!!

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