Invest with Dollar Cost Averaging
By Kristi Vaughan
Here’s an investment tip from which even the most-seasoned of investors can potentially benefit: dollar cost averaging.
What is dollar cost averaging? Simply put, it is a long-term investing strategy that seeks to mitigate the effect of market volatility by investing on a regular basis, no matter whether the market is up or down.
The principle behind the strategy
It is virtually impossible to “time” the market in such a way that you always are buying low and selling high. Dollar cost averaging through systematic investing helps take some of the guesswork out of investment decisions. This happens because you regularly buy shares of the same mutual fund (or funds) on a timed schedule without regard to price. Your constant is the amount you invest. As such, you will buy at both market lows and market highs and the number of shares you buy will vary.
How does it work?
When a fund’s share price declines, an investment buys more shares; when the price rises, the investment buys fewer shares. This helps to even out the fluctuating cost of buying shares.
Let’s say, for example, that you are regularly investing $300 a month in Mutual Fund XYZ. In January the price is $30 per share, including sales fees, so you buy 10 shares. By February the price has risen to $32 a share so your $300 buys 9.37 shares. In March the price rises to 35 per share and your $300 buys 8.57 shares. Your $900 investment is now worth $977.90.
Admittedly, had you invested the $900 in January when, for illustration purposes, the price was its lowest, your investment would have been worth $1,050 at the high price of $35 per share. But what would have happened had the price declined? Or, as the market often does, varied? Reverse the price trend so that shares are priced at $30, $28 and $25 for the three months and you’ll see that if you had invested $900 in January, you would have lost $150 by March when your 30 shares were worth only $750. With a regular $300 investment, you would have 32.7 shares worth nearly $818 for a loss of only about $82. Try some more hypothetical figures and compare for yourself the potential difference between lump sum investing and systematic investing.
Dollar cost averaging through systematic investing does not guarantee that you will make money nor is it a guarantee that you won’t lose money, but it does ensure that you don't buy only at the top or only at the bottom of the market.
A similar strategy can be used in selling investments to ensure that you are not selling only at the low.
Regular investing is easy
Because you are making regular purchases using a timed schedule and a preset dollar amount, it is easy to set up an automatic investing plan through an online bill paying schedule or an automatic debit arrangement from your bank account. In some cases you can even make investments directly from your paycheck. Check with your bank, your employer or the mutual fund company about investment options.
