The “dollar cost averaging” approach to wealth building
Courtesy Strategic Financial Partners, Colorado Springs LIVING WELL Magazine
Slowly but surely wins the race. That’s the moral to the story about the tortoise and the hare. A similar approach, when applied to wealth accumulation, is known as dollar cost averaging. Though not the most glamorous way to increase your net worth, dollar cost averaging may be an effective asset-building strategy, especially when dealing with today’s volatile markets.
Dollar cost averaging is a simple concept. You allocate a fixed-dollar amount to make a particular investment on a systematic, ongoing basis. You select the amount and the frequency of purchases. Some people start with as little as $50 or $100 a quarter; others may prefer several thousand dollars a month. This makes it ideal for the person with long-term goals who wants to budget a set amount from every paycheck for long-term accumulation. The key is to stick with your strategy, pretty much ignoring market shifts, changes, booms and corrections.
How does it work? At first glance, dollar cost averaging does not sound like much. In reality, however, while there are no guarantees when it comes to gains, the results can be highly rewarding. That is because, by purchasing a fixed dollar amount of an asset at regular intervals, you will get more shares/quantity when the price is low and fewer when the price is high. As a result, the average price you pay over the years often works out to be lower than if you tried to time your purchases. Hence, the name: dollar cost averaging.
For Example, let’s say you allocate $100 a month to purchase shares in a carefully selected mutual fund that offers long-term growth potential. After a year, you have invested $1,200. The following chart shows how this (purely fictitious) investment has performed.
|
Month |
Amount Invested | Price per share | Shares Bought |
|
1 |
$100 |
$10.00 |
10.00 |
|
2 |
$100 |
$8.50 |
11.76 |
|
3 |
$100 |
$6.35 |
15.75 |
|
4 |
$100 |
$7.10 |
14.08 |
|
5 |
$100 |
$7.60 |
13.16 |
|
6 |
$100 |
$9.30 |
10.75 |
|
7 |
$100 |
$12.15 |
8.23 |
|
8 |
$100 |
$11.65 |
8.58 |
|
9 |
$100 |
$10.45 |
9.57 |
|
10 |
$100 |
$11.75 |
8.51 |
|
11 |
$100 |
$12.50 |
8.00 |
|
12 |
$100 |
$12.90 |
7.75 |
|
|
|
|
|
| Total
Averages |
$1,200 $100/month |
$120.25
|
126.14 |
Average monthly market price per share: $10.02/share
Average cost: $9.51/share
This hypothetical example is for illustrative purposes only and is not representative of any particular investment.
Over the year, the average monthly market price per share is $10.02 ($120.25 divided by 12). Your average cost per share, however, comes to $9.51 ($1,200 divided by 126.14). Just as important, by budgeting $100 a month, the $1,200 you invested has increased to $1,627.21 (126.14 total year-end shares multiplied by the year-end share price of $12.90). Over time, depending on the amount invested, returns and other factors, dollar cost averaging may be an effective strategy.
Other advantages of dollar cost averaging:
- It helps build discipline. Many accumulation plans are like diets: We start out with conviction, but tend to fall off over time. Dollar cost averaging involves putting a fixed amount of money aside on a regular basis, without excuse or exception. For those who would rather not test their discipline, they can arrange automatic deductions from checking or savings accounts.
- It avoids the hit-or-miss practice of market timing – attempting to buy when a security hits its lowest point and selling when it peaks.
- It is simple. Once the appropriate vehicles are selected, putting aside a fixed amount of money each month becomes automatic.
- It allows you to invest on a limited budget. You do not need large sums to get started.
Is dollar cost averaging right for you? Dollar cost averaging is not for speculators looking for quick gains. Instead, it is tailor-made for individuals who may not have large sums of money, but who see the value of accumulating assets on the “installment plan.”
The best move is to find out more. As a licensed professional, I can review your situation and goals, and discuss whether dollar cost averaging or another strategy is most suitable for your needs. Just give me a call or drop me an email, and we can arrange a time to meet. No cost. No obligation.
Dollar cost averaging does not guarantee profits or protect you against losses in a declining market. Also, since such a program involves regular investment purchases regardless of fluctuating price levels of the investment, consider your financial ability to continue purchasing through periods of low and high price levels.
Contact John Ferguson, CLU, CFS, AIF® and President of Strategic Financial Partners.
