Q.: I inherited some money recently but with the market at all-time highs, I ’m worried I will invest and see it drop immediately. A broker friend says I should dollar cost average. Is that a good idea?
A.: Assuming you are going to be broadly diversified rather than buying just a few stocks, dollar-cost averaging is not a bad idea, but it isn’t great either. It can be somewhat useful as a psychological crutch but historically it has more often cost people money rather than preserved their assets.
Dollar-cost averaging (DCA) is buying into a holding with a fixed dollar amount at fixed time intervals. For example, if you had $120,000 to invest in “XYZ Diversified Fund”, you might buy $10,000 every month for a year. If XYZ’s price drops, only the $10,000 purchases you made prior to that point would be affected and you would actually buy more shares at the lower price with the next purchase. Sounds good, right?