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If you’re already contributing money to a 401(k) retirement account, you may not have realized it, but you’re practicing a popular investment strategy known as dollar-cost averaging.
Simply put, this approach means you’re investing fixed, equal amounts on a regular basis, say monthly or bi-weekly, rather than investing one lump sum of cash all at once.
With a defined 401(k) contribution plan, for example, you’re investing as you earn, regularly taking money from each paycheck throughout the year and putting it into the market. Dollar-cost averaging could also look like if you decide to invest $5,000 of your savings by splitting that cash into five parts, where $1,000 is invested each month for five months.
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Here’s what to know about dollar-cost averaging
Dollar-cost averaging allows you to spread out your investments and buy into the market at different times at varying prices. In turn, these purchase prices ideally balance each other out, which is where the “averaging” part of the phrase comes from.
Experts often recommend this long-term investing approach (especially with broad market-tracking index funds) to people with low-risk appetites since contributing cash consistently over time reduces the impact of any market volatility on an investment. Not to mention, it allows investors to forget about the up and down movements of the market since their contributions aren’t influenced by what’s happening; they’re making contributions at regular intervals no matter what. This helps leave emotion-based investing off the table.
Dollar-cost averaging vs. lump-sum investing
Dollar-cost averaging is often compared with its antithesis, lump-sum investing, an opposite approach otherwise known as simply timing the market.
Like dollar-cost averaging, lump-sum investing can also help you build wealth — and even better, maximize your returns — albeit with the caveat that you’re taking on much more risk. After all, as we all know, no one can really time the market.
When investing a big wad of cash into the market all at once, your money gets put to work immediately. With dollar-cost averaging, however, only some of your money goes into the market to start and the rest is set aside for future contributions — this could allow you to catch future dips in the market, but your immediate gains may be smaller if the market takes off sooner than expected.
Is dollar-cost averaging right for you?
When investing with any method or strategy, the first step is to identify the potential returns as well as your risk tolerance.
Though you may get better returns over time with lump-sum investing, it’s not a good idea for those looking to lower their short-term downside risk since the potential for loss is greater.
Risk-averse investors, or those worried about market volatility, are better off using the dollar-cost averaging investment approach. A good place to start is with an S&P 500 index fund which has shown an average annualized return of approximately 10% since 1957.
For example, Charles Schwab’s S&P 500 Index Fund is a straightforward option with no investment minimum. Its expense ratio is 0.02%, meaning every $10,000 invested costs $2 annually — index funds generally have a 0.2% expense ratio, so this is notably low.
Minimum deposit and balance
Minimum deposit and balance requirements may vary depending on the investment vehicle selected. No account minimum for active investing through Schwab One® Brokerage Account. Automated investing through Schwab Intelligent Portfolios® requires a $5,000 minimum deposit
Fees may vary depending on the investment vehicle selected. Schwab One® Brokerage Account has no account fees, $0 commission fees for stock and ETF trades, $0 transaction fees for over 4,000 mutual funds and a $0.65 fee per options contract
Robo-advisor: Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ IRA: Charles Schwab Traditional, Roth, Rollover, Inherited and Custodial IRAs; plus, a Personal Choice Retirement Account® (PCRA) Brokerage and trading: Schwab One® Brokerage Account, Brokerage Account + Specialized Platforms and Support for Trading, Schwab Global Account™ and Schwab Organization Account
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For an option with no expense ratio, consider the Fidelity ZERO® Large Cap Index Fund. Though the fund doesn’t technically track the S&P 500, the Fidelity US Large Cap Index tracks large capitalization stocks, which the website says, “are considered to be stocks of the largest 500 US companies.”
Minimum deposit and balance
Minimum deposit and balance requirements may vary depending on the investment vehicle selected. No minimum to open a Fidelity Go account, but minimum $10 balance for robo-advisor to start investing. Minimum $25,000 balance for Fidelity Personalized Planning & Advice
Fees may vary depending on the investment vehicle selected. Zero commission fees for stock, ETF, options trades and some mutual funds; zero transaction fees for over 3,400 mutual funds; $0.65 per options contract. Fidelity Go is free for balances under $10,000 (after, $3 per month for balances between $10,000 and $49,999; 0.35% for balances over $50,000). Fidelity Personalized Planning & Advice has a 0.50% advisory fee
Robo-advisor: Fidelity Go® and Fidelity® Personalized Planning & Advice IRA: Fidelity Investments Traditional, Roth and Rollover IRAs Brokerage and trading: Fidelity Investments Trading Other: Fidelity Investments 529 College Savings; Fidelity HSA®
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You can also consider investing a fixed monthly amount through a robo-advisor like Betterment, which will create a custom portfolio of ETFs (which are similar to index funds) for you based on your risk tolerance and investing horizon.
On Betterment’s secure site
Minimum deposit and balance
Minimum deposit and balance requirements may vary depending on the investment vehicle selected. For Betterment Digital Investing, $0 minimum balance; Premium Investing requires a $100,000 minimum balance
Fees may vary depending on the investment vehicle selected. For Betterment Digital Investing, 0.25% of your fund balance as an annual account fee; Premium Investing has a 0.40% annual fee
Up to one year of free management service with a qualifying deposit within 45 days of signup. Valid only for new individual investment accounts with Betterment LLC
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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.