What Is Dollar-Cost Averaging?

Whether you know it or not, when you contribute to your employer-sponsored retirement plan, you’re automatically using a convenient investment strategy: dollar-cost averaging.

What Is Dollar-Cost Averaging?
Dollar-cost averaging is the practice of putting the same amount of money in the same investment option consistently, regardless of the market performance (price) of that investment. Dollar-cost averaging can be beneficial because it allows you to automatically buy more shares when prices are lower and fewer shares when prices are higher. Over time, this tends to reduce the average cost of the shares you purchase.

How Dollar-Cost Averaging Can Benefit Investors
Let’s look at an example of two investors who decide to purchase the same XYZ Stock Option1:

  • Investor A invests $5,000 in a lump sum in XYZ Stock Option in January.
  • Investor B uses dollar-cost averaging to invest $1,000 per month over five months—from January through May.

The chart below shows you how the dollar-cost averaging method, in this case, resulted in a lower cost per share for Investor B.

Purchase Date Amount Invested Price Per share Number of Shares Purchased
Investor A Investor B Investor A Investor B Investor A Investor B
Jan. 15 $5,000 $1,000 $10.00 $10.00 500 100
Feb. 15 $0 $1,000 n/a $6.00 n/a 166.7
Mar. 15 $0 $1,000 n/a $4.00 n/a 250
Apr. 15 $0 $1,000 n/a $7.00 n/a 142.9
May 15 $0 $1,000 n/a $12.00 n/a 83.3
Total Invested Average Price Per Share Total Shares Purchased
$5,000 $5,000 $10.00 $7.80 500 742.9

The results (as shown above):

  • Investor A (invested $5,000 on January 15 when the share price was $10.00): He purchased 500 shares.
  • Investor B (used dollar-cost averaging to purchase $1,000 per month over five months): She purchased 742.9 shares (nearly 50% more than Investor A), at an average price of only $7.80—$2.20 less than Investor A paid per share.

How did this work?
It’s simple: Investor A’s price was set on January 15, when he purchased 500 shares at $10.00 per share. But because Investor B was buying over the course of five months (and share prices go up and down over time), she was able to purchase more shares when the investment was priced lower—and fewer shares when the price was higher.

How You Use Dollar-Cost Averaging In Your Retirement Plan Account
When you contribute to your retirement plan account, you automatically use dollar-cost averaging. That’s because your contributions are deducted from your paycheck and invested directly into the combination of investments you’ve selected—regardless of the prices of those investments. So you buy fewer shares when prices are higher and more shares when prices are lower.

Dollar-Cost Averaging: Important Considerations
  • Dollar-cost averaging can be an effective “automatic investment strategy,” especially for those who find it challenging to save consistently over time.
  • Dollar-cost averaging and other periodic investment plans do not guarantee a profit and do not protect against loss in declining markets.
  • Dollar-cost averaging involves continuous investment in securities, regardless of fluctuating price levels of such securities—and you should consider your financial ability to continue your purchases through periods of low price levels.
  • In “up” markets: When you use dollar-cost averaging, if the prices of the investments you’ve chosen go up, the value of your account should grow, since you purchased more shares when prices were lower.
  • In “down” markets: Dollar-cost averaging can be a valuable tool, because the lower prices give you the opportunity to buy more shares—at “sale” prices.

For More Information
For personal assistance with your retirement savings and investing strategy, consult a financial professional or a Certified Prudential Retirement® Counselor.* Simply call 1-877-PRU-2100 toll free, Monday through Friday, from 8 a.m. to 6 p.m., ET.

 

* Retirement Counselors are registered representatives of PIMS. Many of Prudential Retirement’s Personal Retirement Services Retirement Counselors carry the distinct designation of Certified Retirement Consultants, an advanced certification available through the International Foundation for Retirement Education (InFRE). Certification includes mastery of retirement plan design, investment strategy, retirement income management, and retirement readiness and counseling.

1 This example is hypothetical and not intended to represent the performance of any specific investment.

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