Dollar Cost Averaging

Trying to make a financial killing by timing or "beating the markets" is sometimes a temptation, but it's a strategy that rarely works. Investing is most productive when done over the long term and, in a long race the Tortoise investor will always beat the Hare. Rather than trying to time markets, using a strategy called "dollar cost averaging" can help you to be a successful investor without the risk of poor timing.

Dollar cost averaging is the strategy of investing the same amount at regular intervals - usually monthly.  Mutual funds are the most common investment vehicle for this type of investing because with a relatively small minimum, any amount can be invested and fractional units can be purchased.  Because prices fluctuate, you will buy more shares when markets are low; and fewer shares when markets are high.  By following this strategy, you can often lower the average cost of your investments and if you have lower costs going in, you will have more profit coming out.

There are a number of advantages to dollar cost averaging. You don't have to guess when to buy, and you might be able to sleep better at night. You don't have to invest a large amount all at once; smaller amounts are easier to work into your budget. There is no need to study trends or be a market expert - professional money management is what the mutual fund provides.

Most importantly, dollar cost averaging eliminates the temptation to buy wildly when the price is increasing and stop buying when the price is going down. Many investors feel this tug, but the end result of the temptation is that you buy high. Dollar cost averaging, by contrast, follows the classic advice, "Buy low and sell high".

Let's look at an example of dollar cost averaging when prices are moving up and down. We’ll assume your budget allows you to invest $200 per month for six months.

Month

Unit Price

Units Bought

Amount Invested

Total Value

1

$15

13.33

$200

$200.00

2

$13

15.38

$200

$373.23

3

$14

14.29

$200

$602.00

4

$12

16.67

$200

$716.04

5

$16

12.50

$200

$1,154.72

6

$15

13.33

$200

$1,282.50

 

Average Price

Total Units Purchased

Average Cost Per Unit

$14.17

85.50

$14.03

Your average cost per unit is lower than the average price of the fund. Your $1,200 invested over six months is now worth $1,282.50, a gain of 6.9 per cent. If you had invested your total of $1,200 in month one, you would still have only $1,200 in month six because the price returned to your original $15 purchase price, (assuming there were no dividends paid by the fund and re-invested in the meantime, which would have increased your number of shares). Dollar cost averaging can be a great way to begin a regular investment plan, and can be very profitable in the long run.