We've all likely heard of Dollar Cost Averaging (DCA) before. In my view, it is a steadfast technique that everyone can benefit from in two ways: first it takes the emotion out of investing decisions, and second it may help protect you from a volatile market. (anyone heard if we are having one of those yet?) Maybe you are intentionally using this technique now or maybe, if you are presently contributing to a company retirement plan, you are using it by default. Regardless, I thought a quick review might be helpful.
Dollar cost averaging is simply a practice of systematically investing a reoccurring dollar amount on a regular basis (weekly, monthly, etc.) regardless of fluctuating prices in the market.
By doing so, you invest throughout the market’s various cycles, with the goal to take advantage of its normal shifts, buying more shares when the market is low and less when it is high. This may reduce, over time, the average cost per share for each dollar you invest.
Here's how you can benefit: In a fluctuating market, dollar cost averaging typically results in the average cost per unit being less than the average price per unit. For example: assume $100 investment per month
|Month||Month 1||Month 2||Month 3||Month 4||Month 5|
|Share Price||$10||$8||$12||$10||$10 Average|
|# Units Purchased||10||12.5||8.3||10||40.8|
For illustrative purposes only. Not indicative of any specific investment product.
So the average price per unit over the 4 months was $10. But instead of only buying 40 shares the technique purchased 40.8 shares. This equals an average cost of $9.80 per share $10 average.
Company retirement plans automatically provide this investment technique for you, if you simply enroll. Additionally, you can use the same strategy in other accounts for purchasing other investments you may already own. Keep in mind, though, that dollar cost averaging does not assure a profit or protect against loss in a declining market environment. The technique involves continuous investment in securities regardless of fluctuating price levels. Investors should consider their financial ability to continue purchases through periods of low price levels.
Above is just a simple example over a short period of time. If continued over a number of years, the benefits of Dollar cost averaging can prove significant. Of course there are no guarantees, and in certain market conditions the technique may fail. Yet, this is akin to saying exercise is generally good for one's health, but sometimes it can cause you harm. Most folks who choose to exercise believe the benefits outweigh the risks. I would argue the same holds true for Dollar Cost Averaging.
Pete Thoresen // Financial Advisor// Focus Financial Network, Inc.// 1000 Shelard Parkway, Suite 300 // Minneapolis, MN 55426 // 952-225-0344 (direct) // 952-591-9770 (Main office)
Securities offered through Royal Alliance Associates, Inc., member FINRA/SIPC. Insurance and investment advisory services offered through Focus Financial Network, Inc., a registered investment advisor not affiliated with Royal Alliance Associates, Inc.