The most basic principal of investing is to “buy low, sell high”. Unfortunately, putting that into practice is at best difficult and at worst a dangerous gamble. However, by using a strategy known as “dollar-cost averaging”, you will automatically buy more shares of a stock, mutual fund, or ETF when the price is low and fewer shares when the price is high. Your returns will be greater when your investment does well, and your losses limited if it drops.

Dollar-cost averaging simply means investing a fixed sum of money each month, regardless of price. When the share price of your investment is low, you will automatically buy more shares. If the price is high, you will buy fewer shares. Over time, your portfolio is automatically tilted towards cheaper shares. As a result, if the stock price drops, you lose less, and if it gains, you earn more.

 For example, imagine that you chose to invest $4,000 in Gateway ([1] GTW) on January 1st, 2005. We’ll call this Scenario A. The stock price plummeted from $5.85 to $3.06 over the next 12 months, and by December of 2005 your initial investment of $4,000 would have been worth $2092.31. Today, with Gateway trading around $1.94, you would have $1,326.49 to show for your investment. Lousy, huh?

Scenario A - $4,000 Lump Sum

However, in Scenario B, look at how dollar-cost averaging could have reduced your loss: If you had invested $333.33 each month through the year, rather than plunking down $4,000 on January 1st, your investment would have only dropped to $3,484.23. Today it would be worth $2,208.96. You could have saved yourself a loss of nearly a thousand dollars!

Scenario B - $333.33 per month

 And consider what would happen if the value of Gateway stock suddenly rose to $5 per share. Your investment under Scenario A would be worth $3418.80, a loss of almost six hundred dollars. Under Scenario B, your investment would be worth $5,693.20 - a hefty gain!

Dollar-cost averaging makes sense as an investment strategy for long-term savings, such as retirement or other long term goals. To take advantage of dollar-cost averaging in your retirement savings, simply have the “minimum payment” that we determined yesterday tranferred each and every month into your retirement account and you will automatically hedge against falling prices and reap more rewards when your investments flourish!