3. Financial Concepts: Dollar Cost Averaging
Dollar Cost Averaging
If you ask any professional investor what the hardest investment task is, he or she will likely tell you that it is picking bottoms and tops in the market. Trying to time the market is a very tricky strategy. Buying at the absolute low and selling at the peak is nearly impossible in practice. This is why so many professionals preach about dollar cost averaging (DCA).
Although the term might imply a complex concept, DCA is actually a fairly simple and extremely useful technique. Dollar cost averaging is the process of buying, regardless of the share price, a fixed dollar amount of a particular investment on a regular schedule. More shares are purchased when prices are low, and fewer shares are purchased when prices are high. The cost per share over time eventually averages out. This reduces the risk of investing a large amount in a single investment at the wrong time.
Let's analyze this with an example. Suppose you recently got a bonus for your previously unrecognized excellence (just imagine!), and now you have $10,000 to invest. Instead of investing the lump sum into a mutual fund or stock, with DCA, you'd spread the investment out over several months. Investing $2,000 a month for the next five months, "averages" the price over five months. So one month you might buy high, and the next month you might buy more shares because the price is lower, and so on.
This plan is also applicable to the investor who doesn't have that big lump sum at the start, but can invest small amounts regularly. This way you can contribute as little as $25-50 a month to an investment like an index fund. Keep in mind that dollar cost averaging doesn't prevent a loss in a steadily declining market, but it is quite effective in taking advantage of growth over the long term.
Additional note on Dollar Cost Average from Bruce Curan:
Four things to remember about dollar-cost averaging
1. In the long run, it doesn’t matter when you start, just that you start. Over a long enough period, it makes little difference whether the market was up or down when you began.
2. Making monthly additions to your account allows you three times as many opportunities to benefit from favorable market swings as investing on a quarterly basis. The more frequently you invest and the longer you keep investing, the smoother the average-share-cost line becomes.
3. A market decline can mean bargain prices. Unless you are selling shares, a fund’s price quote in the daily paper is not relevant for anyone who is not planning to sell, so don’t panic if it is down. In fact, a downturn provides the opportunity to buy more shares at attractive prices shares that have the potential to grow in value when the market finally turns upward,
4. Be prepared to weather a sustained market decline. Keep in mind that in order for dollar-cost averaging work, you must be prepared to commit financial resources and have the resolve to make the contributions on each appointed date. Regular investing does not ensure a profit and does not protect against loss in declining markets. Investors should consider their ability to invest continuously during periods of fluctuating price levels.
Savings Plans – there is profit in discipline!
Regular savings plans, preferably monthly funded, thrive on volatility and the rollercoaster times of recession and falling markets. At the end of the road, in a year or three everything starts flying high again, and all those months of purchasing shares at low prices means a massive accumulation of cheap shares. When the investment up cycle returns, the profit sun starts shining again, and the army of shares all march onwards and upwards, and profits flood in…patience and perseverance are the name of the game in the Great Investment Advantage.
Now is definitely the time…
If you ask any professional investor what the hardest investment task is, he or she will likely tell you that it is picking bottoms and tops in the market. Trying to time the market is a very tricky strategy. Buying at the absolute low and selling at the peak is nearly impossible in practice. This is why so many professionals preach about dollar cost averaging (DCA).
Although the term might imply a complex concept, DCA is actually a fairly simple and extremely useful technique. Dollar cost averaging is the process of buying, regardless of the share price, a fixed dollar amount of a particular investment on a regular schedule. More shares are purchased when prices are low, and fewer shares are purchased when prices are high. The cost per share over time eventually averages out. This reduces the risk of investing a large amount in a single investment at the wrong time.
Let's analyze this with an example. Suppose you recently got a bonus for your previously unrecognized excellence (just imagine!), and now you have $10,000 to invest. Instead of investing the lump sum into a mutual fund or stock, with DCA, you'd spread the investment out over several months. Investing $2,000 a month for the next five months, "averages" the price over five months. So one month you might buy high, and the next month you might buy more shares because the price is lower, and so on.
Additional note on Dollar Cost Average from Bruce Curan:
Four things to remember about dollar-cost averaging
1. In the long run, it doesn’t matter when you start, just that you start. Over a long enough period, it makes little difference whether the market was up or down when you began.
2. Making monthly additions to your account allows you three times as many opportunities to benefit from favorable market swings as investing on a quarterly basis. The more frequently you invest and the longer you keep investing, the smoother the average-share-cost line becomes.
3. A market decline can mean bargain prices. Unless you are selling shares, a fund’s price quote in the daily paper is not relevant for anyone who is not planning to sell, so don’t panic if it is down. In fact, a downturn provides the opportunity to buy more shares at attractive prices shares that have the potential to grow in value when the market finally turns upward,
4. Be prepared to weather a sustained market decline. Keep in mind that in order for dollar-cost averaging work, you must be prepared to commit financial resources and have the resolve to make the contributions on each appointed date. Regular investing does not ensure a profit and does not protect against loss in declining markets. Investors should consider their ability to invest continuously during periods of fluctuating price levels.
Savings Plans – there is profit in discipline!
Regular savings plans, preferably monthly funded, thrive on volatility and the rollercoaster times of recession and falling markets. At the end of the road, in a year or three everything starts flying high again, and all those months of purchasing shares at low prices means a massive accumulation of cheap shares. When the investment up cycle returns, the profit sun starts shining again, and the army of shares all march onwards and upwards, and profits flood in…patience and perseverance are the name of the game in the Great Investment Advantage.
Now is definitely the time…
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