Summer School: Dollar cost averaging
We're taking you back to the basics with our summer refresher course on finance terms. Today, learning some restraint with dollar cost averaging.
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Tess Vigeland: OK class, summer school is back in session.
Today: Dollar Cost Averaging -- Highly appropriate after a week that saw the Dow drop to its lowest point of the year. If you're an investor, dollar cost averaging could save you.
At the blackboard: our returning professor, Chris Lowe.
Chris Lowe: The idea of dollar cost averaging is buying into a fund, usually an index fund, where you invest the same amount of money in every period so that what you're going to find is that you own more shares than if you picked an amount of shares to buy every quarter because when the price is down, you'll get more.
People use dollar cost averaging as a disciplinary tool. The temptation as an investor when the market pulls back is to shy away from it and not buy and when the market is strong, the temptation is to chase it and maybe invest a little more than you would otherwise. Dollar cost averaging forces you to have the discipline to buy when stocks are low and use a little more restraint when stocks are high and as a result, over time, it tends to outperform even stock picking, where sometimes we get too smart for our own good and tend to chase after things.
The purpose of it is to prepare you for retirement. The discipline of putting money away every quarter or every month without thinking about and finding at the end that you've probably saved quite a bit more money than you would if you picked the optimal times to invest.
Vigeland: Chris Lowe is an analyst with FTN Financial in New York.
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