KANSAS CITY, Mo. -- The term "dollar-cost averaging" refers to an investing strategy by which you add a fixed dollar amount into a chosen investment on a regular basis over time, as opposed to investing a larger lump sum all at once. This strategy is typically used with stocks or stock funds, since the stock market has ups and downs, explained financial expert Kathy Stepp, with Stepp & Rothwell.
The idea behind dollar-cost averaging is that you don't know when the stock market will go up or down, so by investing a set amount regularly, you will take advantage of downturns by purchasing a larger quantity of your investment.
If you have a sum of money to invest in stocks, you have two choices. You can invest it all at once, or you can invest it in smaller amounts over some period of time. If you believe that the stock market generally moves higher and higher over time, then you may choose to invest your lump sum all at once. However, if you are less sure of the future movement of the stock market, you may want to invest a smaller amount on a regular basis over time, so that if the stock market takes a downward turn you don't have all of your money in it at once, and you can continue your regular investing while stock prices are cheaper.
If you don't have a lump sum to invest in stocks, but you invest a roughly regular amount over time, then you are dollar-cost averaging. This is what you are doing if you participate in a retirement plan in which you contribute through your paycheck.
Because the stock market is unpredictable, you can use the strategy of dollar-cost averaging to avoid trying to time the market to hit a low. If the market continues forever to move upward, you may lose some upside return, but if the market turns downward, you will be happy to have avoided a negative return.