Q

What is dollar cost averaging?

A

It's an investment strategy designed to reduce volatility in a portfolio.

Dollar cost averaging is an investment strategy designed to reduce volatility in a portfolio by purchasing an investment in fixed increments, rather than all at once. Everybody knows the most basic maxim of investment: you want to buy low, sell high. By parceling out an investment purchase over time, say, over a year, you can decrease the chance of the inverse from happening — buying an investment at the exact wrong moment — that is, buying high and watching it go lower.

With dollar cost averaging, if you invest a portion at that moment when the share price is particularly high, you’ll get fewer shares. But if the next time you buy, its price is considerably lower, you’ll acquire more shares for the same price. The idea underpinning the strategy is that by tiptoeing into the shallow end of an investment rather than cannonballing with all your money, you will decrease your chances of overpaying by purchasing the investment at an average price — not a particularly high or low one. The downside is that by remaining on the sidelines, you run the real risk of missing out on growth should the investment’s share price soar. Though the little-bit-at-a-time method might provide some peace of mind for the nervous investor, the body of evidence on the topic suggests that you’re better off buying the investment all at once, because, historically, stocks spend more time going up than they do going down.

Wealthsimple is investing on autopilot

Get started in just 5 minutes, and your first $5,000 is managed free.

Learn more