If fear of the mar­ket keeps you up at night, one of the best and most effec­tive ways to take advan­tage of any mar­ket event, good or bad, is to con­sid­er using an invest­ment strat­e­gy called dol­lar cost aver­ag­ing. You can auto­mate this method to force you to invest on a reg­u­lar basis regard­less of mar­ket con­di­tions.

With dol­lar cost aver­ag­ing, you invest the same dol­lar amount at reg­u­lar inter­vals over time. By con­sis­tent­ly fol­low­ing this strat­e­gy, you may be able to reduce the impact of mar­ket fluc­tu­a­tions on your invest­ment port­fo­lio.*

For exam­ple, let’s say that you decide to invest $300 each month toward retire­ment. As the fol­low­ing illus­tra­tion shows, you auto­mat­i­cal­ly buy more shares when prices are low and few­er shares when prices are high:

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Your reg­u­lar month­ly invest­ment of $300 bought more shares when the price was low and few­er shares when the price was high. The result? The aver­age cost of the shares you pur­chased is less than the aver­age mar­ket price per share over the peri­od.

Dol­lar cost aver­ag­ing is often favored by those who wish to make their peri­od­ic invest­ment a part of their month­ly bud­get. The amount invest­ed each month is pre­dictable. An auto­mat­ic invest­ment plan ensures that the pre­de­ter­mined amount is prop­er­ly invest­ed at appro­pri­ate inter­vals. Among oth­er things, this relieves you of the con­cern and emo­tion­al bur­den that comes with try­ing to decide when, and how much, you should be invest­ing when the price of your secu­ri­ties is ris­ing or falling. Experts sug­gest that this strat­e­gy works best with a sin­gle invest­ment vehi­cle that reg­u­lar­ly fluc­tu­ates in price.

Remem­ber that since dol­lar cost aver­ag­ing involves con­tin­u­ous invest­ment in secu­ri­ties regard­less of those secu­ri­ties’ fluc­tu­at­ing prices, you should con­sid­er your abil­i­ty to con­tin­ue pur­chas­es through peri­ods of low price lev­els. Also, all invest­ing involves risk, includ­ing the pos­si­ble loss of prin­ci­pal, and there can be no guar­an­tee that any invest­ing strat­e­gy will be suc­cess­ful.

Mak­ing dol­lar cost aver­ag­ing work for you by:

  • Start­ing as soon as pos­si­ble. The longer you have to ride out the ups and downs of the mar­ket, the more oppor­tu­ni­ty you have to build a size­able invest­ment account over time. 
  • Stick with it. Dol­lar cost aver­ag­ing is a long-term invest­ment strat­e­gy. Make sure that you have the finan­cial resources and the dis­ci­pline to invest con­tin­u­ous­ly through all types of mar­kets, regard­less of price fluc­tu­a­tions. 
  • Take advan­tage of auto­mat­ic deduc­tions. Hav­ing your invest­ment con­tri­bu­tions deduct­ed and invest­ed auto­mat­i­cal­ly makes the process easy and con­ve­nient.

The best way is to use pay­roll deduction/bank autho­riza­tion to fund your invest­ment pro­gram. If you want to invest grad­u­al­ly over a peri­od of time, you can autho­rize your employ­er or bank to send a spec­i­fied amount of mon­ey at spec­i­fied inter­vals auto­mat­i­cal­ly to your invest­ment bro­ker. That way, invest­ing becomes con­ve­nient and auto­mat­ic, mak­ing it eas­i­er for you to pur­sue your goals.

The advan­tage is that it makes reg­u­lar invest­ing easy. You can use auto­mat­ic pay­roll deduc­tion or bank autho­riza­tion to imple­ment a peri­od­ic invest­ment approach, such as dol­lar cost aver­ag­ing.

Peri­od­ic invest­ing is a strat­e­gy where­by you make reg­u­lar invest­ments on a month­ly, quar­ter­ly, or year­ly basis. The plan has a set pay-in peri­od and a mech­a­nism to with­draw funds from the plan after that time.

There are sev­er­al forms of peri­od­ic invest­ing, but they all have the same goals: (1) to make invest­ing auto­mat­ic and elim­i­nate the need to “time” the mar­ket, (2) to help smooth out mar­ket price fluc­tu­a­tions, and (3) to reduce the risk of loss dur­ing a down­turn in the mar­ket.
It also min­i­mizes the temp­ta­tion to spend mon­ey else­where. Using pay­roll deduc­tion or bank autho­riza­tion can help you save mon­ey because you won’t be tempt­ed to spend it else­where.

The easy part is how to do it. Most employ­ers who offer qual­i­fied retire­ment plans allow you to con­tribute through auto­mat­ic pay­roll deduc­tion. Some employ­ers also allow employ­ees to con­tribute to per­son­al sav­ings accounts and/or invest­ment funds. An employ­er also may enable you to pur­chase elec­tron­ic U.S. sav­ings bonds through a pay­roll sav­ings plan (though you must first set up a Trea­sury­Di­rect account). Set­ting up auto­mat­ic pay­roll deduc­tion is usu­al­ly as sim­ple as con­tact­ing your employ­er and fill­ing out paper­work that autho­rizes the trans­ac­tion and spec­i­fies the amount to be deduct­ed each pay peri­od.

If you want to trans­fer funds direct­ly from your bank account to your invest­ment pro­gram, you must also autho­rize the trans­ac­tion. Con­tact your bank and/or bro­ker to find out the pro­ce­dure.

Tip: Many bro­ker­age hous­es and large mutu­al fund com­pa­nies also offer accounts and ser­vices sim­i­lar to those at banks, so you may be able to have earn­ings from one account auto­mat­i­cal­ly trans­ferred to fund anoth­er type of invest­ment.

If you want to buy an indi­vid­ual stock, you may have the options of par­tic­i­pat­ing in a div­i­dend rein­vest­ment pro­gram (DRIP). A DRIP auto­mat­i­cal­ly rein­vests your share­hold­er div­i­dends in more shares of the same com­pa­ny’s stock. When you are due a div­i­dend, you are issued more shares of stock instead of a cash div­i­dend pay­ment. In some cas­es, the issu­ing com­pa­ny will cov­er the bro­ker’s fees and may even pro­vide the addi­tion­al shares at a dis­count­ed price. That means you get more bang for your invest­ment buck. These plans allow com­pa­nies to raise cap­i­tal with­out con­duct­ing a new pub­lic offer­ing of secu­ri­ties.

In addi­tion to those bonus­es, you ben­e­fit by accu­mu­lat­ing shares in the com­pa­ny auto­mat­i­cal­ly and incre­men­tal­ly over the long term. In that regard, DRIPs have advan­tages sim­i­lar to those pro­vid­ed by auto­mat­ic invest­ment plans. Peri­od­i­cal­ly, a por­tion of your income (in this case, div­i­dend income) is auto­mat­i­cal­ly invest­ed with­out the need for you to make a sep­a­rate invest­ing deci­sion each time.

DRIPs also have some advan­tages sim­i­lar to those of dol­lar cost aver­ag­ing plans. Your invest­ments are made peri­od­i­cal­ly so that you can take advan­tage of fluc­tu­a­tions in the mar­ket and hope­ful­ly achieve an over­all low­er aver­age share price than if you made a one-time invest­ment at the wrong time. Remem­ber, to achieve the advan­tages of a diver­si­fied port­fo­lio, you do not want to invest all of your sav­ings in only one DRIP. By invest­ing in a num­ber of DRIPs offered by dif­fer­ent com­pa­nies in var­i­ous indus­tries, you can reduce your port­fo­lio’s expo­sure to the risk that shares of one of the com­pa­nies will decline in val­ue.