Dollar cost averaging is an elegantly simple investment technique. You invest the same amount of money each month (or other interval) whether the shares are going up or down in price. Over time, you may achieve a lower average cost per share compared to the share price for a lump-sum investment, and you will establish a disciplined approach to investing.
Dollar cost averaging can be accomplished with modest or substantial sums of money. In the case of mutual funds, your choices are governed by the amount you intend to invest. Some funds set minimal initial and subsequent investments as low as $50, while others require a starting base of $1,000 or more.
Probably the easiest and most practical way to get in the habit of dollar cost averaging is to establish an automatic bank draft between a mutual fund and your bank. The same amount of money is withdrawn on a specified date every month and transferred to the fund of your choice.
To see how dollar cost averaging can take advantage of highs and lows in market prices, study the example shown below. The accompanying chart shows a hypothetical comparison between a one-time lump-sum investment of $400 and four separate $100 investments over a period of time. While the total amount invested is the same in each case ($400), dollar cost averaging results in a lower cost per share.
Dollar Cost Averaging in Action
One-Time Lump-Sum Investment vs. Dollar Cost Averaging
Amount Share Shares Amount Share Shares
Invested Price Bought Invested Price Bought
| $400 | 10 | 40 | $100 | 10 | 10 |
| $100 | 5 | 20 | |||
| $100 | 10 | 10 | |||
| $100 | 16 | 6.25 |
—— ——
Totals: $400 40 $400 46.25
Avg. Cost per Share: $400/40 = $10 Avg. Cost per Share: $400/46.25 = $8.65
(Figures are for illustrative purposes only and are not indicative of any particular security.)
Furthermore, with a lump-sum investment, if the market value of your shares declines, your total investment decreases in value; all you can do is wait for the value of your shares to increase.
In contrast, with regular periodic investments, you get more shares when the price falls, and you buy them at lower prices. As long as share prices eventually increase, your average cost per share will always be lower than the current cost per share.
When investing, always keep in mind that investment return and principal value of funds will fluctuate due to market conditions. When shares are redeemed, they may be worth more or less than their original cost.
Though dollar cost averaging is hardly a new technique, investors may find that it works particularly well in today’s unpredictable investment climate. It can be applied to the purchase of individual stocks, mutual funds, and variable annuities.
One reason that dollar cost averaging seems to work favorably for so many investors is that it provides a disciplined approach to investing. This is a necessary ingredient for establishing a complete long-term plan!
-Jared
