New to investing? Use dollar cost averaging

One of the biggest worries many investors have revolves around the question: When?

As in, When should I invest my money?

Lets say you receive a windfall of $20,000. If you invest it in the stock market today, the market might go up tomorrowand keep going up, making your investment really pay off.

On the other hand, the market could tank right after you buy in. In that case youd be kicking yourself for being too hasty: If only youd waited a few days, the price of your investments would have plunged, and your $20,000 would have bought many more shares!

Fortunately, theres a way to invest without worrying about timing. Its known as dollar-cost averaging. And if you participate in a workplace retirement plan such as a 401(k), theres a good chance youre already practicing it.

Dollar-cost averaging is the opposite of lump-sum investing. Its the practice of putting the same amount of money to work in the market at regular intervals. If lump-sum investing is investing that $20,000 all at once, dollar-cost averaging might mean investing a chunk of money each month$1,000 a month for 20 months, for example, or $2,000 a month for 10 months.

In dollar-cost averaging, we buy the same investment or investments consistently, whether the price of those investments is headed up or down, with equally-sized chunks of our money. The appeal of dollar-cost averaging is that it allows you to automatically buy more shares when prices are lower and buy fewer shares when prices are higher. Over time, this generally reduces the average cost of the shares you purchase.

Those of us who contribute a fixed amount of every paycheck into our 401(k) plan are dollar-cost averaging, perhaps without being aware of it. Our contributions are invested directly into the combination of investments weve pre-selected, regardless of changes in their prices. Whether were aware were practicing dollar-cost averaging or not, it can be a smart investing strategy.

Heres a simple example to illustrate how it works. Suppose Investor A and Investor B each has $5,000 to invest. Investor A invests $5,000, in a lump sum, in a stock that costs $10 per share. Investor B, however, invests just $1,000 at first, buying shares at the same $10 level. Then he invests $1,000 in each of the next four months; when the stock price happens to be $6, $4, $7 and $12, respectively. In other words, Investor B is buying more shares when the stock is priced lowerand fewer when its priced higher.

Thanks to that dynamic, Investor B will own 742.9 shares of stock after five months, compared with 500 shares for Investor A. And should that stock rise over the years, Investor B will make more money simply because he owns more shares.

No investment strategy guarantees that youll make money, of course. Investments can and do rise and fall over time. But dollar-cost averaging is a strategy that can help to improve your odds of success.