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Dollar-cost averaging means purchasing an investment (such as shares of a mutual fund) in batches, spread out over a period of weeks or months, rather than all at once. With each batch, you invest the same dollar amount - $500/month, for example.
Dollar-cost averaging doesn't guarantee that you'll do better or worse, but it reduces the risk of investing all of your money at what turns out to be a bad time. The approach also takes the guesswork out of deciding exactly when to make your purchases. That can be a good thing, given the human tendency to avoid buying when the stock market is down, even though your potential for gains may be greater then.
Because you buy the same dollar amount each time, the result will be that your average price per share is lower than the average price of the investment over the dates you made your purchases. The reason is that you'll be buying more shares when the price per share is low, and fewer shares when the price per share is high.
How does that work? Here’s a simple example showing four $500 purchases in an imaginary mutual fund:
Batch #1
$500 at $5 per share: 100.000 shares purchased
Batch #2
$500 at $4.75 per share: 105.263 shares purchased
Batch #3
$500 at $4.65 per share: 107.527 shares purchased
Batch #4
$500 at $5.75 per share: 86.956 shares purchased
Now you own 399.746 shares for a total cost of $2,000, and your average price per share was $5. But the average of these four prices is higher than that - it's $5.04. Because you kept investing the same $500 each month, you bought more shares at $4.65 and fewer at $5.75, and lowered your average price per share.
