Dollar cost averaging

One handy way to build your investment portfolio gradually involves a popular investment strategy called dollar cost averaging. When you use this approach, you invest the same dollar amount every month or every quarter in the same fund or company.

Because you invest regularly (ideally through automatic deposits into your account), you’re providing a regular cash infusion to build your account value. By investing through the market’s ups and downs, you also can avoid paying only the highest prices.

Here’s how it works: The price per share will tend to move up and down over time. When the price is up, you buy fewer shares with your investment dollars. And when the price is down, you buy more shares.

Making the strategy work

Dollar cost averaging is attractive, especially when the markets are strong and you can see that your account is increasing in value. But to allow this strategy to work, it’s important that you continue to invest even in periods when the market is down and the value of your investment may be dropping. If you stop buying when the price drops, you will have paid only the higher prices and won’t reduce your average share cost.

The bottom line

That doesn’t mean you should continue to throw good money after bad investments if a fund or a company seems unlikely to recover. There may be a point when the wisest decision is to cut your losses. But understanding how the regular buying strategy can work in your favor may give you the incentive to ride out a market downturn.

Dollar cost averaging can be effective, and it does make investing easy, but you do have to remember that it doesn’t ensure that you’ll make a profit. And it can’t protect you from losses in a falling market.