UPDATE: How can much can dollar-cost averaging shield me from loss?
By Dan Moisand
We may be better off learning to be resilient rather than nimble
Everyone prefers that their investments go up in price immediately after buying but the opposite happens frequently too. Dollar-cost averaging is often touted as a way to soften the blow of an immediate decline.
Q.: I have cash I know should be invested but I am nervous about the markets. It has been suggested that I dollar cost average to protect against losses. How much loss protection should I get with that?
-- Bob in Memphis
A.: Bob, dollar-cost averaging is not a bad technique, but it isn't a full cure for market jitters.
Dollar-cost averaging (DCA) is buying into a holding with a fixed dollar amount at fixed time intervals. For example, you would buy $10,000 of "XYZ" monthly for a year rather than $120,000 on day one. If XYZ's price drops, you get more shares with the next purchase so that is better than having bought all shares at the higher price. However, markets usually trend upward.
For DCA to pay off the market has to decline, and by enough, and for long enough, to get a lower average price than a lump sum initial purchase would produce. The longer one stretches out the investment, the better the odds the market will not do this. Most studies of the technique have diving in at one time producing the better result than a 12 month buy-in about two-thirds of the time regardless of how high the market is when you start.