Guideline-managed portfolios use a dollar-cost averaging strategy to protect your retirement savings against market fluctuations. Dollar-cost averaging helps you to steadily accumulate investments without trying to predict the market. Dollar-cost averaging takes place when a fixed dollar amount of a certain investment is purchased regularly, no matter what its share price is. The benefits of dollar-cost averaging are reaped when the shares of that same investment are sold at a price higher than the average price paid for them.
Contributions to a 401(k) plan are a form of dollar-cost averaging. You’re using a predetermined portion of your paycheck each pay period to purchase the same allocation of fund shares, regardless of the market price.
So how does dollar-cost averaging work exactly?
Peter Planner decides to buy $1,000 of Organic Orangutan Oculars (OOO) stock a month for four months beginning in January. OOO shares decline for the first three months, but then rebound in April.
After making consistent $1000 purchases over four consecutive months, Peter owns 201 shares in OOO. His average price per share is approximately $19.90 ($4,000/201 shares). OOO’s share price is $22 at the end of April, which is higher than Peter’s average price per share of $19.90. So, despite the share price dropping from $25 in January, Peter still makes a profit of $422 at the end of April!
Dollar-cost averaging works best with no-load (or no commission) mutual funds. “No-load” means there is no fee for buying or selling an investment, so that you won’t pay anything additional when you buy in each pay period. By utilizing dollar-cost averaging, you’ll be able to put your investments on autopilot and watch your savings grow over time.