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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.
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