In the financial markets, as in poker, there is great anxiety with going “all in” or investing all of your money at one particular point in time. What if today is the “high”, as in the old adage to be a successful investor you should buy low, and sell high? No long-term investor wants to buy at the market’s peak. But how do you avoid it, if you don’t have the inclination or expertise to try and time the market? The answer is dollar cost averaging.
Simply put, dollar cost averaging (commonly referred to by the acronym DCA) is an investment strategy that reduces the risk of going “all in” at the wrong time, by investing a fixed or set dollar amount in a security at a specified interval, usually monthly, over a period of time. You buy fewer shares for the same dollar investment when the price per share of a security is higher and more shares when the price per share is lower, thus leveling out the price that you pay for your investment shares overall. You may even already be implementing this type of strategy, if you invest a specific dollar amount each pay period into a retirement or other savings plan.
Let’s see how DCA works using an example. Below are the purchase prices for investment ABC on the 5th of each month. If we had $600 to purchase investment ABC, with dollar cost averaging we could invest $100 on each of those dates and buy the following share amounts:
January 5th: ABC price = $15, purchased 6.67 shares ($100/$15);
February 5th: ABC price = $15.50, purchased 6.45 shares ($100/$15.50);
March 5th: ABC price = $14, purchased 7.14 shares ($100/$14);
April 5th: ABC price = $16, purchased 6.25 shares ($100/$16);
May 5th: ABC price = $15.75, purchased 6.35 shares ($100/$15.75);
June 5th: ABC price = $16.50, purchased 6.06 shares ($100/$16.50);
Total investment = $600. Total shares purchased = 38.92 shares
Our total investment in ABC is now 38.92 shares. Notice that we bought more shares in January and March, and a fewer number of shares in April and June, effectively buying more of our fictitious investment at the “lows”. That’s the beauty of dollar cost averaging. You don’t have to worry about timing your investments, instead you invest over time.
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