Dollar cost averaging is a simple strategy investors can employ to smooth out market volatility.
It is almost impossible to time the market perfectly when investing. Not only is the risk that an investment is made at the “wrong time” but the greater risk is that in waiting for the “right time” you’re not invested in the market at all. The risk of getting the timing wrong can be minimised, however, if the investment is made over a set period of time.
Dollar Cost Averaging is most effective when investing in a volatile or falling market as your regular, set investment amount buys less when the market’s up and more when the market’s down.
This concept relies on the principle that capital wealth is best built over the long term by time spent participating in the market as opposed to trying to “time” the best moment to get in and out of the markets.
With dollar cost averaging, you don’t have to worry about where share prices or interest rates are headed. You simply invest a set amount of money on a regular basis over a long period of time.
Below is a simple example that illustrates how it works based on investing $100 per month into a managed investment that initially had a unit price of $10. Over the next few months, the market falls, (causing the unit price to drop) before recovering to its original value.