Investing 101: How to Invest Money

When you're learning how to invest money, it's a good idea to understand the basic vocabulary. Dollar cost averaging is a phrase that sounds confusing. Like most things, it's easy once you understand it. =-)

Dollar cost averaging allows you to invest at predetermined times for a set amount. For instance, you might decide to invest (buy) $100 per month of shares in a company or a mutual fund.

What is the Benefit?

Dollar cost averaging reduces your risk and lowers your overall cost over time.

An Example of Dollar Cost Averaging

An investor buys shares by purchasing small amounts over a period of years. Doing this spreads the costs (cost basis) out over several years. As a result, you don't buy (spend) too much at one time.

Let's says that the stock we choose to purchase sells for the prices below during our first months using dollar cost averaging:

Month 1: Stock Price is $50 per share

Month 2: Stock Price is $25 per share

Month 3: Stock Price is $75 per share

Let's say we decided to buy $500 worth of stock each month. With our $500, we buy 10 shares during month 1, 20 shares during month 2, and 6.6 shares during month 3.

We spent $1500 over the span of three months and now own 36 shares.

If we'd bought all of the shares during month one, we would only own 30 shares. We would have paid more for each share, too.

If we'd bought all of the shares during month two, we'd own 60 shares. We would have paid the least if we'd been fortunate enough to buy them all during this month.

If we'd bought the shares during month three, we would have paid the most and would only have 20 shares.

The "Magic" of Dollar Cost Averaging

Using this tried and true method, you are able to take advantage of the price when the market is low while not having to watch the stock market's every move. You have time to live your life! Although you can get lucky if you watch the market on a regular basis -- see month two above as an example -- most people don't want to hassle with it.

This method can be set up to make your investments on a weekly, monthly or quarterly basis.