Dollar-Cost Average When Share Prices Decline

As with most recessions, you probably will not see the next one coming. But you will likely see a sell-off in the stock market well in advance of a recession. When that happens, remember the first lesson: There is recovery after a recession.

Knowing that, investors can take advantage of a declining market through the dollar-cost averaging method of investing. If you make monthly contributions to a qualified retirement plan, you are already using the technique. But when the market starts to plunge, it is time to take advantage by increasing your contributions or starting dollar-cost-averaging in a non-qualified investment account.

When you dollar-cost-average your investing, you are gradually reducing your overall cost basis in the share price, so when the price rebounds, your cost basis is always lower than the price. For example, if you invest $500 a month in a mutual fund selling for $25, your contribution buys 20 shares. If the share price drops to $20, your contribution buys 25 shares. Your account now has 45 shares with an average cost basis of $22.

As the share price drops, your $500 contribution buys an increasing number of shares and your cost basis continues to drop. When share prices rebound, your contribution buys fewer shares each month, but the current share price is always higher than your cost basis. The dollar-cost-averaging method works best over the long term for investors who do not want to worry about how their investments are performing.