Ask a Fool: What's the Best Way to Invest in Expensive Stocks?

Q: I'm thinking of buying some Microsoft stock, but with shares at record highs, I'm worried that it may be due for a drop. What can I do?

One strategy I like to use when I'm afraid a stock could be due for a pullback is called dollar-cost averaging. You can apply this to Microsoft, or to any other stock you're thinking of investing in.

Dollar-cost averaging simply means buying a set dollar amount of stock at regular time intervals in order to build a position. For example, if you want to buy $6,000 of Microsoft stock, you could invest $2,000 today, another $2,000 in three months, and the final $2,000 in six months.

Here's why it works: The obvious reason is the one you stated -- if Microsoft stock goes down over the next few months, you'll be able to take advantage and buy some shares at a lower price. On the other hand, even if the stock doesn't go down over time, dollar-cost averaging ensures that you'll get a mathematically favorable price.

As a simplified example with round numbers, let's say that Microsoft trades for $100 today (it's actually about $110), so your $2,000 would buy 20 shares. In three months, the stock trades for $80, so you would buy 25 shares with the second $2,000. And in six months, Microsoft has shot up to $125, so you'd buy 16 more shares with the final $2,000.

You would now have 61 shares of Microsoft at an average cost of $98.36 each. Meanwhile, the average stock price among the three days you made your purchases ($100, $80, $125) is $101.67. By averaging into a position, you'll ensure that you're getting a below-average price and will also protect yourself in the event that the stock drops.