Dollar Cost Averaging

One of the best ways to invest is to put in a fixed amount of money at regular intervals.  This style of investing is naturally available to you if your work has a 401K program, or something similar.  With a 401K program, a fixed amount is taken out of each paycheck and invested in the fund that you choose.  If you don't have this kind of program at work, then you can create the same effect by choosing a set amount of money to invest each month.  Of course, you should have met the prerequisites of investing before starting such a program.

Why is this a good way to invest?  Well, suppose you are buying a stock, and you decide to purchase 10 shares a month for a year.  At the end of the year, you will have 120 shares.  The stock price fluctuates during the year, lets say in the range $25 to $40.  To make this example concrete, suppose the price goes like this during the year:

	Price	Shares	Investment
	$25	10	$250.00
	$25	10	$250.00
	$30	10	$300.00
	$25	10	$250.00
	$30	10	$300.00
	$35	10	$350.00
	$40	10	$400.00
	$30	10	$300.00
	$30	10	$300.00
	$25	10	$250.00
	$30	10	$300.00
	$35	10	$350.00
Total		120	$3,600.00

This was a pretty good investment!  You put in a total of $3,600 and at the end of the year it was worth 120 * $35 = $4,200.  But is this the best you can do?

Suppose instead of buying 10 shares each month, you invested $300 each month.  Your total amount invested would be the same as in the previous example, but what would be the value of the investment at the end of the year?  Using the same price history, your investment would accumulate like this:

	Price	Shares	Investment
	$25	12	$300.00
	$25	12	$300.00
	$30	10	$300.00
	$25	12	$300.00
	$30	10	$300.00
	$35	8	$280.00
	$40	7	$280.00
	$30	10	$300.00
	$30	10	$300.00
	$25	12	$300.00
	$30	10	$300.00
	$35	8	$280.00
Total		121	$3,540.00

Actually, since I only allowed an integer number of shares to be purchased each month, you invested less than in the previous example.  But you ended up with more shares than before!  You invested a total of $3,540 and ended up with an investment worth 121 * $35 = $4,235.

How is this possible?  Well if you look at the details, you can see what is happening.  Each month you put in the same amount of money.  So if the price is low that month you buy more shares.  If the price is high you buy fewer shares.  That means on average you are getting a better price, since you are buying more shares at the lower price.  This is called Dollar Cost Averaging, hence the title of this column.

So, for your next investment, whatever it may be, put the power of Dollar Cost Averaging to work for you!