Dollar-Cost Averaging

Rule #3 of Investing

In chapter four of my book, The Effective Investor, I explain that there are only two ways you can follow Rule Number Three of the Three Rules of Investing, of “buy low and sell high” without any speculation or gambling. The first way is called dollar-cost averaging. I explain the second way in chapter eleven of my book.

Rather than trying to time the market and making a single purchase, many investors use a method called dollar-cost averaging. Using dollar-cost averaging, you buy the same investments at regular intervals with a fixed amount of investment dollars. When you practice dollar-cost averaging, you buy more shares when prices are low and fewer shares when prices are high. Over a period of time, as market prices fluctuate, the average cost per share of your shares bought will be less than the average price per share. For example, assume that a person invests $100 per month for 12 months in XYZ investment.

Month Dollars Invested                    Price per Share                    Number of Shares Purchased
Jan   $100                                             $11.00                                   9.09

Feb   $100                                             $13.00                                   7.69

Mar  $100                                             $9.00                                    11.11

Apr  $100                                             $11.00                                    9.09

May $100                                            $12.00                                    8.33

Jun $100                                              $8.00                                    12.5

July $100                                              $9.00                                    11.11

Aug $100                                             $10.00                                  10.00

Sept $100                                            $12.00                                     8.33

Oct $100                                              $11.00                                     9.09

Nov $100                                              $8.00                                   12.50

Dec $100                                              $11.00                                    9.09

Total $1,200                                     $125.00                                 117.94

The average price per share: ($125.00/12) = $10.42

The average cost per share: ($1,200/117.94) = $10.17

Ibbotson Associates did some research and found that a hypothetical investor who would have invested $100 a month in Wall Street for 30 years starting in September 1929 would have seen that total investment of $36,000 grow into a $411,000 nest egg by September 1959.11 This is a good argument for dollar cost averaging for the long term investor. Remember Rule Number One is to be in it for the long run.

Another reason for dollar cost averaging is because many people are hard-pressed to come up with a lump sum of say, $150,000 to invest. Dollar cost averaging allows people to contribute equivalent amounts toward retirement savings, a little at a time. Don’t get confused here and think if you have a lump sum of money to invest, and you have a long-term objective with that money, that you should dollar cost average that lump sum over a 20-30 year period. If you have a lump sum, it would be better to get the full amount invested. You always want your money working for you as soon as possible. The dollar cost averaging principal is useful for those who don’t have a lump sum to invest.

The best part of dollar cost averaging is how automatic it is. You eliminate trying to time the market and are following Rule Number Three. You can go out and live your life and simply get that quarterly statement showing your on-going contributions to the account. It is “off your plate,” but never neglected. Investments must be regular and the same amount each time. If the investor discontinues the plan when the market value is less than the cost of the shares, he or she will obviously lose money.12 The investor must be willing and able to invest during the low price levels when their emotions and the media may be saying to stop or pull out.

Secret Number Six in building extraordinary wealth is DOLLAR COST AVERAGING, or in other words, always be adding money to your portfolio on a regular basis. The best way to accomplish this is to set up an automatic withdrawal from your bank account weekly. This will put you on “auto-pilot investing.”

The point here is that you don’t have to use speculative methods of stock picking and market timing in order to be a successful investor. What you do have to do is follow the three rules of investing.

If your or someone you know needs some help managing retirement assets, setting up a retirement savings plan, or have life insurance needs, just give me a call at 801-545-0696.
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All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment. This material was prepared by MarketingLibrary.Net Inc., for Mark Lund an independent fee-only Investment Advisor, Investor Coach and the author of The Effective Investor. Located in Salt Lake City and Provo Utah.