Dollar-Cost Averaging

Dollar-Cost Averaging is an investment strategy where an investor allocates a fixed amount of money to purchase a particular asset at regular intervals, regardless of the asset’s price.

Understanding Dollar-Cost Averaging

This strategy is designed to reduce the impact of volatility on the overall purchase. Instead of investing a large sum of money at once, investors gradually buy into an asset, which means they can potentially buy more shares when prices are low and fewer shares when prices are high.

Benefits of Dollar-Cost Averaging

• Reduces impact of volatility: By spreading out purchases, investors can mitigate the effects of market fluctuations.
• Encourages disciplined investing: Regular investments can help build a saving habit and avoid trying to time the market.
• Less emotional stress: A fixed investment schedule takes emotion out of the decision-making process.

How Dollar-Cost Averaging Works

1. Determine a fixed investment amount.
2. Select the frequency of investment (e.g., monthly).
3. Purchase the selected asset at each interval using the fixed amount.

Example of Dollar-Cost Averaging

Imagine an investor who decides to invest $100 in a particular stock every month for five months. The stock prices are as follows:

• Month 1: $10
• Month 2: $20
• Month 3: $15
• Month 4: $25
• Month 5: $30

Calculating Shares Purchased

• Month 1: $100 / $10 = 10 shares
• Month 2: $100 / $20 = 5 shares
• Month 3: $100 / $15 = 6.67 shares
• Month 4: $100 / $25 = 4 shares
• Month 5: $100 / $30 = 3.33 shares

Total Shares Acquired

After five months, the total shares purchased would be:

• Month 1: 10 shares
• Month 2: 5 shares
• Month 3: 6.67 shares
• Month 4: 4 shares
• Month 5: 3.33 shares

Total shares: 10 + 5 + 6.67 + 4 + 3.33 = 29 shares

Total Investment and Average Cost Per Share

The total amount invested over the five months is:

Total investment: $100 x 5 = $500

The average cost per share can be calculated as follows:

Average cost per share = Total investment / Total shares = $500 / 29 = approximately $17.24

This approach demonstrates how Dollar-Cost Averaging allows an investor to accumulate shares over time while potentially benefiting from purchasing shares at different price points, resulting in a lower average cost per share.