Dollar Cost Averaging
Dollar cost averaging takes some of the risk out of investing in fluctuating markets because it removes the factor of deciding when to invest.
The basis of dollar cost averaging is that you invest a set amount on a regular basis, no matter whether the market is up or down.
When the market is up, your set amount purchases fewer units because prices have increased, but your existing holding is worth more. When the market is down, your existing holding is worth less because prices have fallen, but new units are cheaper to buy and, subsequently, you purchase more units.
Typically, over the long term, the average cost of units purchased will be lower than the average price of the units over the same period.
How it works:
Assume you invested $200 per month into an investment where the unit price fluctuates from month-to-month.
|Month||Amount invested||Shares purchased||Share price|
Final account balance = 2432 @ $0.52 each
Average share price over the period = $0.50
Average cost of shares purchased = $0.49
This is an example of how investing regularly can reduce the cost of investing.
It can also show that if we spent the entire $1200 up front and bought 2400 shares, our share would have a value of $1248. This represents a 4% increase in six months.
But, because we used dollar cost averaging,we have increased our profits to $1265, (or an increase of 5.4%), while reducing risk over the six months.