THE POWER OF DOLLAR COST AVERAGING
Ask any astute investor what the key to successful investing is and the answer may be patience. This is perhaps the most difficult lesson any investor can learn.
Hand-in-hand with patience goes the discipline of investing for the long term. Many money managers will tell you that a long-term approach to investing is generally a wise choice for individual investors.
Dollar-cost averaging is an important tool investors can use to bring discipline to an investment portfolio. This method of systematic investing may help reduce investment risk. Let's imagine that you use a periodic investment program in which you select a stock and then buy the same number of shares each quarter, no matter what the price. You buy 100 shares each quarter for four quarters, and sell the whole investment in the fifth quarter (Case A).
Now let's use the same stock, with the same price movement—but instead of buying 100 shares each quarter, let's say you're investing $1,000 each quarter. Again, you sell the whole investment in the fifth quarter (Case B).
Here are the results of the two strategies:
Case A1
| March |
$1,000 |
$10 |
100.00 |
|
|
| June |
800 |
8 |
100.00 |
|
|
| September |
1,000 |
10 |
100.00 |
|
|
| December |
1,200 |
12 |
100.00 |
|
|
| March |
|
13 |
|
400 |
$5,200 |
|
Case B1
| March |
$1,000 |
$10 |
100.00 |
|
|
| June |
1,000 |
8 |
125.00 |
|
|
| September |
1,000 |
10 |
100.00 |
|
|
| December |
1,000 |
12 |
83* |
|
|
| March |
|
13 |
|
408 |
$5,308 |
*Note: Investors may not be able to purchase partial shares ($1000/12 = 83.33 shares. The $4.00 difference is added into the proceeds calculation). This example is for illustrative purposes only and is not indicative of any specific security. Figures do not include commissions, dividends, taxes, and other charges that may apply to the transactions.
In both cases, you've invested the same total amount of money in the same stock at the same times, at the same prices, and sold at $13 a share.
But by investing the same amount of money each period, you've bought more shares when prices were low, fewer shares when prices were high. So instead of 400 shares for your original investment of $4,000, you bought 408 shares. Your average price per share was $9.80 instead of $10. The result? In this example, dollar-cost averaging would have put you about $108 ahead.
Of course, dollar-cost averaging in itself does not ensure a profit. If you sell your shares at less than the average price you paid for them, you'll have a loss. However, dollar-cost averaging does lower the price you have to get to break even. Because dollar-cost averaging involves continuous investment in securities regardless of fluctuating price levels, you should consider your financial ability to continue to invest through periods of low prices before participating in this strategy.
If you can set aside a specific amount of money periodically, and invest it in a security you're making full use of dollar-cost averaging—an investment discipline that may make sense for intermediate- and long-term investors.
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