Investing 101 — Dollar Cost Averaging

Finance-Stock Ticker

While the stock market has historically shown to trend upward over a long period of time, the market fluctuates daily. Dollar Cost Averaging is a long-term approach to investing that regularly invests a specific amount of money despite how the market changes in the short-term.

An investor using Dollar Cost Averaging commits to investing a certain amount of money in a stock on a regular basis. For example: a person invests $100 at the beginning of every month in ABC Stock. Using this method, the $100 investment buys more stock in the months the stock value is low and less stock when the value is high. Over the long-term, the hope is that the average cost per share for the investor will be less than the average price per share. 

Dollar Cost Averaging is not an effective strategy in a steadily declining market. Additionally, if an investor were to abandon this plan when their chosen stock’s market value is less than the cost of shares, they would lose money.

Let’s take a look at a simplified example using Facebook stock. Here are the monthly open values of Facebook’s stock from June 2012 to May 2013 according to Yahoo Finance.

Date

Price Per Share

Dollars Invested

Number of Shares Purchased

June 1, 2012

 $     28.89

 $     100.00

3.46

July 1, 2012

 $     31.25

 $     100.00

3.20

August 2012

 $     21.50

 $     100.00

4.65

September 1, 2012

 $     18.08

 $     100.00

5.53

October 1, 2012

 $     22.08

 $     100.00

4.53

November 1, 2012

 $     21.08

 $     100.00

4.74

December 1, 2012

 $     28.00

 $     100.00

3.57

January 1, 2013

 $     27.44

 $     100.00

3.64

February 1, 2013

 $     31.01

 $     100.00

3.22

March 1, 2013

 $     27.05

 $     100.00

3.70

April 1, 2013

 $     25.63

 $     100.00

3.90

May 1, 2013

 $     27.85

 $     100.00

3.59

Total

 $   309.86

 $  1,200.00

47.75

In this example, the average price of each share is $25.82 ($309.86/12). The investor’s average cost per share is $25.13 ($1,200/47.75). Using Dollar Cost Averaging, the investor spent $0.69 less per share than the stock’s average cost. Additionally, if the investor were to have bought $1,200 worth of shares on June 1, 2012 instead of using Dollar Cost Averaging, he would only have 41.54 shares.

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