Building your 401(k) know-how: What’s dollar cost averaging?

An employer’s 401(k) plan is one of the most effective ways to save for retirement. And while many individuals are familiar with the potential tax benefits they receive by participating, there’s another important, but less talked about, benefit called dollar cost averaging.¹ It’s an investment strategy that comes with regular investing, such as in a 401(k), and may help retirement savers optimize their investments over time.

Dollar cost averaging—a systematic strategy to investing

Dollar cost averaging is a fancy way of saying that you’re investing a set amount of money regularly, regardless of whether the financial markets are moving up or down. And it’s an inherent part of how you save for retirement through your employer’s 401(k) plan.

When you enrolled in your plan, you selected a contribution amount and an investment you felt would help you attain your retirement goals. Each pay period, the money is automatically deducted from your paycheck and invested in the fund you chose. While your contribution remains the same each time (for example, $100), the number of fund shares you get varies based on the price at the time of the investment. When the price of the fund goes up, your $100 purchases fewer shares than when the price is lower, but, over time, the highs and lows average out.

That’s why dollar cost averaging is one of the key benefits of participating in your employer’s 401(k) plan. It can help smooth out market fluctuations to help you build your retirement savings.

Dollar-cost-averaging example

Each pay period, Mary contributes $100 to her 401(k) account, and the money is invested in mutual fund ABC. Assuming she’s paid monthly, here’s how many shares her $100 contribution buys:

Pay period

Contribution

Price of mutual fund ABC

Shares purchased

January

$100

$15

6.67

February

$100

$20

5.00

March

$100

$17

5.88

April

$100

$25

4.00

May

$100

$22

4.55

June

$100

$30

3.33

This is a hypothetical example for illustrative purposes only.

Total investment: $600

Total number of shares purchased: 29.43

Average share price: $21.50

Buying shares when the price is lower reduces the average long-term price of mutual fund ABC, which can help improve Mary’s long-term return on investment. It also increases the total number of shares in her 401(k) account, helping her make progress on her financial goals.

Other benefits of dollar cost averaging

One of the ripple effects of systematic 401(k) contributions and dollar cost averaging is that they can help you avoid making investment decisions based on emotion. Whenever the financial markets experience a steep decline, such as during the Great Recession of 2008 or the pandemic, many people are tempted to stop contributing to their 401(k) or transfer their account to a more conservative investment option. While these feelings are understandable, acting on them may throw your retirement savings off track—and it can potentially take years to make up the missed savings. Knowing that your contributions are actually working harder for you (buying more shares) during downtimes can help you fight the temptation and keep your savings moving in the right direction.  

Additionally, dollar cost averaging can help ease anxiety about investing in the financial markets. Since you’re making regular contributions, you don’t have to worry about trying to determine the right time to invest to get the “best” price, a concept known as market timing.

Staying focused on the future

Saving for retirement is a marathon, not a sprint. And market fluctuations are to be expected. Some days, your 401(k) balance will be higher than others. The key is not to let the day-to-day fluctuations distract you from your long-term vision. By making regular 401(k) contributions, you’re putting the power of dollar cost averaging to work for your future.

 

1 Dollar cost averaging does not guarantee a profit or protect against a loss. Systematic investing involves continuous investments in securities, regardless of price-level fluctuations. Participants should consider their resources to continue the strategy over the long term.  There is no guarantee that any investment strategy will achieve its objectives.

For complete information about a particular investment option, please read the fund prospectus. You should carefully consider the objectives, risks, charges and expenses before investing. The prospectus contains this and other important information about the investment option and investment company.  Please read the prospectus carefully before you invest or send money. Prospectus may only be available in English.

The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.

MGT-I 45475-GE 07/21-45475 MGR0913211819256