Dollar cost averaging is an investing strategy that is designed to nullify the risk of investing all of your cash all at once. If you buy a portfolio all as a lump sum, then you become at the mercy of the market. For example, if you bought your assets at a high point in the market, you would be subject to immediate losses as the market corrected itself. While the major indices like the S&P 500 trend upward, it could be years before your investments begin to see the improvements that you expect from them.
When you use dollar cost averaging, this risk disappears. Everyone knows that the stock market is much higher today than it was back in 1930, and this strategy takes advantage of this truth. In 1930, the nation was in the beginning stages of the Great Depression, and stocks were far from people’s minds. However, if you had invested $1 back in 1930 with an annual addition of another $1, gaining 3% every year (the average rate of increase in the S&P per year) for 85 years, you would now have much more than the $85 you’ve contributed total. You would now have $401, or more than 4 times what you had put in.
If you had put in $85 total then, you’d have more than $401 now (you’d have over $1,000, actually), but not if you wanted to pull it out after a couple years. And, because the market was so small then, the situation now is completely different. Now, things are far too unpredictable to approach this in the same way. This method is also a form of protection, then. It allows you to have a much better chance of avoiding the negative effects of the ups and downs that the market sees. Yes, you will find yourself contributing during market tops once in a while and your contributions will lose money right off the bat, but you will also see the exact opposite of this, too. You will be putting money in at relative low points, and your money will grow even faster. In the end, this strategy offsets the bumps and dips in the road and allows you to grow your money more safely without worrying about the timing of that one lump sum you wanted to invest. It smooths things over and makes your growth chart look more like an unrestricted upward moving line.
This strategy can be used with variable annuities, and by splitting up contributions to your other retirement vehicles rather than making lump sum deposits. If you do choose to go with a fixed rate annuity, dollar cost averaging doesn’t apply. Your investment here will be getting a return one way or another, and the markets’ activities do not matter. This is the big appeal of this sort of investment, and if fluctuations worry you, this will be a safer and more calming way to approach your retirement. If you are concerned about market entry and investment timing, then this is something to consider. And it’s actually really easy to set up. When you meet with your insurance agent or financial advisor, just let them know that you want periodic deposits taken from your bank account. Rather than writing out one big check then and being done, you will see a monthly (or whatever your choose) deduction taken from your account and credited to your investment. Most people do this already anyway, but never consider the fact that it’s actually a risk reducing strategy designed to keep your retirement funds growing with more consistency and predictability.