To take advantage of ups and downs in the price of stocks, many investors, including myself, utilize Dollar Cost Averaging (DCA) as a strategy.
DOLLAR COST AVERAGING: is an automated and disciplined investment strategy. It removes emotions from the investment process because you are investing a fixed amount of money at set periods. As the price of an ETF, Mutual Fund, or stock varies from month to month, you acquire the ETF or stock at an average price per share over the year(s). This has the effect of smoothing out the price you pay for your investment over time. And allows you to purchase more shares when the price is low and fewer shares when the price is high since the dollar amount of money-invested stays the same each month.
Another added benefit: Getting you in the market and earning a return instead of sitting on the sidelines in a low interest savings account. The longer you wait the greater risk you never invest in equities. JUST GET STARTED!
HOW DOES DOLLAR COST AVERAGING WORK
Dollar-cost averaging is a wealth-building strategy that involves investing a fixed amount of money at regular intervals over a long period. The concept is similar to making routine payments into your 401K and 403(b) retirement plans on paydays. Every paycheck adds the same amount to your retirement account whether the market is going up or down. The amount of money invested at each interval remains the same over time, but the number of shares purchased varies based on the market value of the shares at the time of purchase. When the markets are up, you buy fewer shares per dollar invested, due to the higher cost per share. When the markets are down, the situation is reversed, and you purchase more shares per dollar invested.
The real value of dollar-cost averaging is that investors do not have to worry about investing at the top of the market or trying to determine when to get in or out of the market. DCA AVOIDS WHAT WE ALL FEAR – THE RISK OF BAD TIMING! If you invest your money all at once in a particular investment, there is the risk that you will invest just before a big market downturn.
EXAMPLE DOLLAR COST AVERAGING WITH APPLE STOCK
You see constant ups and downs but more importantly you see a 10-year up trend. DCA can be effectively utilized if you want to get started investing with smaller dollar amounts on a routine bases.
In January 2008, Apple stock sold for ~$12.19 and as of November 8, 2018 it sold for $207.91. You practice dollar cost averaging by making scheduled purchases of $250 on the first Monday of the month, over the past 10 years regardless of price.
In 2008 your $250 purchased $250/$12.19 =20.50 shares and in 2018, November you purchased $250/$207.91 = 1.2 shares.
You made 118 purchases over the last 10 years, spending $29,599. As of November 7, 2018 your account has a balance of $121,299, off of a $29,599 investment.
WARREN BUFFETT AND BENJAMIN GRAHAM
Dollar-cost averaging, was a favorite practice of Warren Buffett’s mentor Benjamin Graham. By investing a set dollar amount in the same investment at fixed intervals over time you buy more shares when prices are low and less shares while prices are high. Remember those 20.51 Apple shares you purchased in 2008 at $12.19. As of November 8, 2018, those shares are now worth $297.91/share x 20.51 shares = $4,264.23.
Berkshire Hathaway uses Dollar Cost Averaging and buys a desired stock after the price has declined to “a fair or low value, versus on a set date.
Warren Buffett agrees Apple stock is a good/great long-term investment. Berkshire Hathaway is the second-largest holder of Apple shares with a stake worth about $52 billion and growing. Buffett explains his love for Apple stems less from short-term financial performance and more from the power of its brand and ecosystem. “I do not focus on the sales in the next quarter or the next year,” ……”I focus on the … hundreds, hundreds, hundreds millions of people who practically live their lives by it [iPhone].” Warren Buffett.
Buffett also called the iPhone “enormously underpriced, “saying that it’s worth far more than the $1,000 Apple charges for its.”
• Dollar Cost Averaging works whether, or not, you believe in it.
• Dollar Cost Averaging automatically insures you will buy more shares at a lower price – and fewer shares at a higher price, over the long term.
Hopefully anyone eligible for a 401-K Plan is utilizing DCA and contributing at least enough to collect company-matching funs. This is an excellent way to get started.
With today’s internet stock/equity accounts it is easy to set up your IRA or Non Retirement Accounts and contribute set amounts on set dates (Example – Pay Days, etc.) If you do NOT have an account open one. If you have an account:
1. Select investments to purchase, such as S&P 500 ETF or stocks.
2. Determine the dollar amount and frequency you want to make a deposit and buy shares of your selected equity.
3. Tie your investment account either to your Payroll deposit or your checking account and have the preselected funds transferred to your investment account.
4. You can set up a calendar reminder to yourself to initiate a purchase on the first of each month (for example).
5. The good news, simply call your Investment firm and a representative will help you set up DCA.
Advantage to dollar-cost averaging is that by investing mechanically, you will take the emotional component out of your decision-making. You will continue on a preset course of buying a certain dollar amount of your preferred investment irrespective of how wildly the price swings. This way, you will not bail out of your investment when the price goes down in a wild swing, but rather see it as an opportunity to acquire more shares at a lower cost.
There are times when lump sun investing may be better than dollar cost averaging. The idea behind lump sum investing is that the longer you have your money in the market, the more money you will make. Lump sum investing works best if you have a large amount of money to invest at one time.
Remember we only buy equities we will hold for years. Example: If you had the $30,000 cash in January 2008, and believed in Apple, you would have made much better returns versus taking 10 years to invest the $30,000. But how many of us have $30,000 sitting in coffee cans around the house? For those of us looking to invest strategically over time, I recommend Dollar Cost Averaging.
Thank you to all my readers for reading this week’s blog and other blog articles.
I am a proud nerd (my beautiful wife and daughter told me so) investment and finance blogger, with a Rutgers, MBA and Harvard, Advanced Management. I am a successful investor in equities and real estate and happy to share my personal finance and investment lessons learned with you. I am NOT however, a licensed financial advisor. Please do not construe my suggestions on this blog, as recommendations for your personal situation. For individual finance advice please seek your own licensed CPA or financial advisors.