The strategy behind dollar cost averaging consists in making regular contributions of a set dollar amount towards the same fund or stock over a long period of time regardless of the market conditions in contrast to investing a lump sum all at once. Many of us are already doing this in our retirement plans, as we are setting aside a percentage of our income towards our retirements. That money is then invested in the funds that you or your plan administrator has selected for you inside your retirement plan. This form of investing allows you to purchase more shares when prices are low and fewer shares when prices are high, averaging out the cost of your investment.
|Date||Price Per Share||Shares||Cost|
|Average Price Per Share:||$14.69|
Let’s see how it works. Consider investing $1,000.00 per month over the next four months into a fund with relative volatility. The first month you invest $1,000.00 at $20.00 per share purchasing 50 shares, the second month the price is down to $15.00 per share where your $1,000.00 purchases 66.66 shares, the third month the price is down to $10.00 per share and you obtain 100 shares, the fourth month the price is now $18.00 per share and your $1,000.00 equates to 55.55 shares. In total over the four months you have purchased 272.22 shares spending a total of $4,000.00, dividing the cost by the total number of shares your average price per share is $14.69. See further examples with dollar cost averaging the S&P 500.
Broad diversification of your investment portfolio being one of the most important things that you can do for your investments, think of dollar cost averaging as the diversification of time. By diversifying your investment over a select time period, it reduces the risk that you’re investing at an inopportune period of the market.
If you are thinking that it would just be better having purchased all the shares at the $10.00 value, you are right it would have been. However timing the market for the average investor is a sucker’s game, even with all of the information available these days there is no way to know when the market will go up or down and by how much. Dollar cost averaging may not be the most effective investment strategy when looking for total return verse that of investing a lump sum at one moment but most of the world does not have large cash reserves sitting around to invest in one lump sum. Dollar cost averaging is one investment strategy to adopt to ensure that some of your savings goes to work for you.
Most importantly, the practice of dollar cost averaging creates a good habit of investing for your future. Every dollar that can work for us in the longer time horizon the more secure we will be in the future when we need the money. Leave a comment below and let’s start a better money discussion.