Understanding Dollar-Cost Averaging and It's Benefits As An Investor

The world of investing can be intimidating when first getting started. There are various strategies, platforms and tools that have burst onto the scene to make things easier for the do-it yourself investor. For the long-term investor there is one strategy that can be beneficial to the health of your portfolio. The strategy I’m speaking of is known as dollar-cost averaging.

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Dollar-cost averaging involves two core elements.These two core elements are 1.) investing a specific dollar amount monthly, let's say $100 or $200 and 2.) doing it for a long period of time, let’s say three, five or 10 years. This is very crucial as the most benefit is received from dollar cost averaging the longer a person decides to invest. Dollar-cost averaging or (DCA) takes advantage of market swings to provide the best average return on your money.

For example, Instead of dumping $10,000 into the stock market all at once for a stock that costs $100 at that time. Buy the stock regularly over longer periods of time to take advantage of the stock fluctuations, yes I said take advantage of the fluctuations. A drop in price can be viewed as buying at discount  say the same $100 stock drops to $90, you saved $10 in a sense. Or if you buy when it goes up in value to say $110 than naturally the stock will cost more and your monthly $100 contribution will buy you less than one share.

Remember when the stock goes up, the value of all previous shares purchased go up as well. You are likely taking part in dollar cost averaging if you contribute to a 401k or have a mutual fund because these funds regularly take your set dollar contribution or percentage and buy shares or portions of shares each time you contribute either monthly or bi-monthly.

To make things clearer, I’ll provide a practical example. Sally contributes $100 per month to her 401K which purchases shares of the S&P 500 Index. In January one share is $100 so she buys one share. In February the index drops to $50 per share so she is able to buy two shares with her same $100. In March it jumps back up to $100. As we go into April the stock takes a hit again and goes down to $33 per share so she was able to acquire three shares. May’s index value goes back up to $50 per share and in June the price goes back up to it’s original price of $100. At the end of June Sally now owns 10 shares of the S&P 500 index. If she would have bought six months or $600 worth of shares all in the month of January, Sally would have netted just six shares. Dollar cost averaging allowed her to get more bang for her buck in the four extra shares that were added to her portfolio.  

This is just an example and I’m not representing a guarantee of these similar results. However, the example is to display the power of DCA to any portfolio. Similar can be done for purchasers of individual stocks. Pick a strong stock you can afford to buy on a monthly basis and buy as many shares as you can, but it must be done every month!