To remain financially responsible, everyone must pay bills
on a regular basis. These bills include mortgages, utilities, car loans and
credit cards. Unfortunately, many people do not also heed the oft-quoted advice
to pay themselves first.
The reality is that a steady saving and investing plan is
sometimes necessary to help pursue such financial goals as paying for a wedding
or new car, buying a house and funding retirement. One strategy that can help
you develop a systematic investing plan, while potentially saving you money and
easing your mind along the way, is dollar cost averaging (DCA).
Dollar cost averaging is a technique in which investments of
defined amounts are made on a regular basis.1 As a long-term,
disciplined strategy, DCA can help you take advantage of the benefits of
compounding to potentially build a sizable sum.
Aside from offering a disciplined, trouble-free way to save
and invest, another potential benefit of using DCA is that it ensures that your
money purchases more shares when prices are low and fewer when prices are high.
Over time, the result could be that the average cost to you may be less than
the average share price. For example, consider the accompanying chart, which
shows the result of investing $50 in stocks every month for 12 consecutive
months.2
As you can see, every month the share price fluctuates a bit,
and by the end of the 12-month period, your $600 would have bought you 42.7
shares. The average price per share, as calculated by adding up the monthly
price and dividing by 12, would have been $14.25. However, the average cost
that you would have actually paid, as calculated by dividing the total amount invested
by the number of shares, would have been $14.05 per share. Over the years, this
method could potentially save you a lot of money.
|
Month
|
Share Price
|
Shares Bought
|
|
Jan.
|
$15
|
3.3
|
|
Feb.
|
$13
|
3.8
|
|
Mar.
|
$12
|
4.2
|
|
Apr.
|
$14
|
3.6
|
|
May
|
$13
|
3.8
|
|
June
|
$12
|
4.2
|
|
July
|
$13
|
3.8
|
|
Aug.
|
$14
|
3.6
|
|
Sept.
|
$16
|
3.3
|
|
Oct.
|
$16
|
3.1
|
|
Nov.
|
$17
|
2.9
|
|
Dec.
|
$16
|
3.1
|
|
Total Shares
|
42.7
|
|
|
Average Price Per
Share
|
$14.25
|
|
|
Average Cost Per
Share using DCA
|
$14.05
|
|
Dollar cost averaging also can offer the psychological comfort
of easing into the market gradually instead of plunging in all at once.
Although DCA does not assure a profit or protect against a loss in declining
markets, its systematic investing “habit” helps encourage a long-term
perspective, which can be soothing for people who might otherwise avoid the
short-term volatility of riskier, but potentially more profitable, investments,
such as equities.
And last, DCA may help you make savvy investment decisions
if you stick with it. For example, if your investment rises by 10%, you will
likely post big gains because of the shares you have accrued over time. And if
it declines by the same amount, take comfort in knowing that your next
investment will purchase more shares at a less expensive price—shares that may
regain their value and even exceed the higher price in the future.3
As a long-term strategy, you may find DCA can help to potentially
lower your average cost per share, while allowing you to feel more comfortable
during uncertain markets. Keep in mind, however, that you should consider your
ability to purchase over long periods of time and your willingness to purchase
through periods of low price levels.
1Periodic investment plans do not assure a profit
and do not protect against loss in declining markets. Dollar cost averaging is
a strategy that involves continuous investment in securities regardless of
fluctuating price levels of such securities, and the investor should consider
their financial ability to continue purchasing through periods of low price
levels.
2Source: Standard & Poor’s. Stocks are
represented by the S&P 500 index.
3Past performance is no guarantee of future
results.
This article was is not intended to provide specific
investment advice or recommendations for any individual. Consult your financial
advisor, or me, if you have any questions.
________________________________
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