To remain financially responsible, everyone must pay bills on a regular basis. These bills include your house payment, Dish Network with the HD package, water bill, Sirius satellite radio and few of the other essentials out there. Unfortunately, many people do not follow the same concept was it comes to investing.
The harsh reality these people may discover 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. Everybody as their own opinion on the right way to generate wealth. One approach that is often seen consistently is called dollar cost averaging (DCA).
Please keep in mind that systematic investing does not ensure consistent market gains. 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.
Dollar cost averaging is a technique often used in buying mutual funds in which investments of defined amounts are made on a regular basis. As a long-term, disciplined strategy, DCA can help you take advantage of the benefits of compounding to potentially build a sizable sum. Consider the accompanying chart, which shows the result of investing $100 in stocks every month from January 1998 to December 2007.1
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AVERAGE PRICE PER SHARE:
AVERAGE COST PER SHARE:
Other Long-Term Benefits of DCA
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 the long term, the result could be that the average cost you pay for the shares may be less than the average price. Assume you invest $50 per month in an investment for 12 months and every month the share price fluctuates a bit. You can see that your $600 total would have bought you 42.7 shares. The average price per share, as calculated by adding up the monthly prices 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.
In addition, DCA 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 the 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’ve 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.
Regular Investing Makes Sense
While investing a lump sum at the most opportune time can potentially profit you more than if you dollar cost average your investment, defining “opportune” is difficult for even the most seasoned experts. As a long-term strategy, you may find DCA to be more appropriate to help potentially lower your average cost per share, and allow you to feel more comfortable during uncertain markets knowing that you made sound investment decisions. 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.
1Source: Standard & Poor’s. Stocks are represented by the S&P 500.
2Richard E. Williams and Peter W. Bacon, “Lump Sum Beats Dollar Cost Averaging,” Journal of Financial Planning, April 1993, pp. 64-67.
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