Investing Advice

Dollar Cost Averaging

As you buy additional blocks of shares, $50 or $100 at a time, you are taking advantage of what is known as "dollar cost averaging".

Most books on investing take you through silly charts showing that regular investments over a period of time will build your investment at an average share price below the average NAV for the same time period (they avoid a rising market example).

What dollar cost averaging really means is when you invest a regular dollar amount, such as $50 a month, you buy fewer shares when the price is high, and more shares when the price is low. When ultimately your mutual fund share price has risen higher, you have lots of shares that you bought on sale, and only a few that you had to pay a premium for. That's dollar cost averaging.

But remember, in a rising market, you are buying most of your shares at higher prices, and very few at lower prices.

In the early stages of a bear market though, this averaging definitely works to your advantage.

A real life example of dollar cost averaging

On Jan 1, 1992, one person invests $3,000 in the T. Rowe Price S&P 500 Equity Index Fund. Five years later, with the fund yielding an average 16.82 annual return, this investment has grown to $6,488.

Another investor, not having $3,000 to plunk down all at once, elected to invest $50 each month in this same fund. Over these same 5 years, a total of $3,000 was also invested.

But since only $50 was originally put to work, and then a total of $100, $150, and so forth, this investor's account had grown to "only" $5,010. But due to dollar cost averaging, with his $50 buying more shares when they were cheap and fewer shares when they were expensive, his average annual return was 19.45%

Note that the same $3,000 "invested" in 1992 in a bank CD (where you are actually loaning your money to the bank) would have grown to only $3,270 over the same 5 years, just one-half of what the S&P index fund yielded.

Other Stock Market Basics Topics:

  1. Mutual Fund Advantages
  2. History of Mutual Funds
  3. NAV
  4. Dollar Cost Averaging
  5. General advice about choosing a fund
  6. Mutual Fund Ratings
  7. Evaluating Mutual Fund Investment Risk
  8. Mutual Fund Share Classes
  9. Mutual Fund Fees
  10. The Mutual Fund Prospectus
  11. How important is the manager's length of experience?
  12. Why is the prospectus hard to understand?
  13. Mutual Fund Annual Report
  14. Comparing your fund to the competition
  15. Comparing funds on an after-tax basis
  16. Average Return on Investment
  17. How Not to Pick a Mutual Fund
  18. Cashing in Your Fund
  19. When to Sell Your Fund
  20. Mutual Funds and Asset Allocation
  21. When to get started with a mutual fund
  22. Types of Mutual Funds
  23. Value Stock Funds
  24. Growth Stock Funds
  25. Small and Micro-cap Stocks
  26. Mid Cap
  27. Large Cap Companies
  28. Income Stock Funds
  29. Mutual Fund Index
  30. Enhanced Index Funds
  31. Sector Mutual Funds
  32. Stock Market Sectors
  33. Defensive Stocks
  34. International Funds
  35. Real Estate Mutual Funds
  36. Socially Responsible Funds
  37. Balanced Funds
  38. Tax-Efficient Funds
  39. Bond Convertible Funds
  40. Junk Bond Funds
  41. Mixtures of stock types
  42. Closed End Funds
  43. Exchange Traded Funds (ETF’s)
  44. Stock Picking Strategy - Picking your own stocks?
  45. Fund names, and what they really invest in
  46. How to get started
  47. Where can I start investing with no money?

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