Dollar Cost Averaging Can Be an Effective Strategy

You may have heard of dollar cost averaging, which is the process of making small investments at regular intervals over time. But have you tried it? You may find it worthwhile because it can be an effective investment strategy.

Dollar cost averaging establishes discipline; you build a habit of regular investment to help you reach your long-term goals. And by investing regularly over time, you’re not worried about trying to time the market.

In fact, it can help you take advantage of market fluctuations. Because you invest the same dollar amount each period, you typically purchase more shares when prices are low and fewer shares when prices are high. This means that over the entire purchase period, your average cost per share could be lower than the investment’s average price per share.

Dollar cost averaging works for just about any type of investor with any amount of money to invest. If you don’t have much to invest, dollar cost averaging can be a great way to ease into investing because you can start with a relatively small amount of money.

On the other hand, if you have a large sum to invest (such as an inheritance or proceeds from the sale of a home), you can put it into a savings or money market account, then move small portions into a stock or bond mutual fund over time.

Of course, deciding whether to use a dollar cost averaging strategy depends on your individual financial situation.

Your advisor can help you make the right choice.

Consider Bond Durations to Help Manage Risk

The volatility of the current market has driven some investors out of stocks and into bonds, which are often perceived to be less risky.

But bonds also have risks – most notably, interest-rate risk. This risk, however, can be managed if you understand the concept of duration.

Generally speaking, bond prices move in the opposite direction of interest rates. Higher interest rates drive bond prices down and vice versa. The risk that your bond price will fall because interest rates rise is called interest-rate risk.

When purchasing shares of a bond fund, you can help manage interest-rate risk by paying attention to the fund’s duration. Duration is a number that indicates the percentage change in the price of a bond fund for each 1% change in the interest rate.

For example, if the bonds in a particular fund have an average duration of three years, for each 1% change in interest rates, the bond fund’s price should move 3% in the opposite direction of the interest-rate change. The lower the average duration of a bond fund, the less price sensitivity the bond should experience.

What does this mean for you?

If you are a risk-averse investor, you may want to consider bond funds with shorter durations. In the event that interest rates rise (and prices drop), you don’t want to be “locked in” to bonds that don’t mature for several years. With rising interest rates, bonds with longer durations will actually be worth less than newly purchased bonds.

If, however, you purchase faster-maturing bonds – those with shorter durations – you’ll be able to replace the lower-price bonds as they mature.

Many investors are concerned about what to invest in given the volatile market.

While bonds remain good investments, you can minimize the risk by understanding the concept of duration and making it work for your individual situation.