Retirement Meditation #10: What is dollar-cost-averaging?

Insights | Retirement Meditation #10: What is dollar-cost-averaging?

Author: Paul A. Carl, CHSA, CPFAVice President, Retirement Plan Consulting, Registered Representative

While my goldendoodle, Bear, lays by my chair snoring, I’m thinking about rollercoasters. Why am I thinking about rollercoasters? Because I’m recalling a graphic around 2008/2009 that depicted a side-view of rollercoaster tracks. It showed a rollercoaster’s upward climb, its peak and then its descent to the bottom where it reversed course and began its ascent once again. 

The rollercoaster graphic was meant to represent the investment markets which can go up and then down and then up and then down…It also illustrated the effects of human emotion and dollar cost averaging with the rise and fall of the investment markets.

From an emotional lens, who doesn’t enjoy checking their account balances frequently when the investments are mostly going up? Conversely, who completely shuns looking at their statements when investments are swinging in the opposite direction?

As for dollar cost averaging, the technical definition reads something like this: “An investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase.” 

In more familiar terms, dollar cost averaging happens when funds are added to the same investment(s) in a systematic and regular interval. Interestingly, it can remove emotion from the investment decision because sometimes the investor is buying on the way up to a peak, and other times the investor is buying on the way down to a bottom where it reverses course once again.

When you contribute to your 401(k) plan throughout the year, you are dollar cost averaging. Each pay period, your employer forwards your contribution amount to the retirement plan recordkeeper. The recordkeeper invests your contributions in the investment options you have chosen or in the retirement plan’s default option. When investments rise in value, you are buying fewer units or shares of the investments; when investments decline in value you are buying more units or shares. Over time, the contributions that get invested are dollar cost averaged.

Are you using dollar cost averaging to your full advantage?

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