By BRIAN HEPP
As any seasoned investor will tell you, the markets are constantly fluctuating.As a result, deciding when to invest can sometimes be a complicated process. And usually few people “win” when they try to time the market. To help alleviate the stress of making such difficult timing decisions, you can use a strategy known as dollar cost averaging to maintain a regular pattern of investing and help smooth out the effects of market fluctuations.
Dollar cost averaging is a systematic approach to investing that takes the emotion — and, more importantly, market conditions — out of your investment decision-making process. Using the system, you set aside a set dollar amount to invest, regardless of current market prices or trends.The amount needed to contribute to a dollar-cost averaging program will vary with the investment you choose, but you can usually begin with as little as $50.
In addition to setting the investment amount, you can decide how often you want to invest, but you would typically set up a system of either monthly or quarterly investments. For example, you could decide to invest $100 in stocks every month, and once you set up your program it becomes automatic — you don’t even have to think about it.
It may be intuitive, but it’s still worth mentioning that dollar-cost averaging allows you to buy more shares when the price is low, and buy fewer shares when the price is high. It’s important to remember that this method does not guarantee you will make a profit, nor does it protect you against loss if the investment purchased declines in value.
Because-dollar cost averaging doesn’t ensure a profit or protect against loss, you should carefully consider your ability — both emotional and financial — to stick with such a program, especially during rising and falling markets.However,if you feel this strategy could be right for you, the only thing you need to do is decide on a plan and get started.To help illustrate the benefits of a dollar-cost averaging program, consider the following example.
In this hypothetical investment scenario, we will take a look at how our strategy fares in a fluctuating market over a five-month period. Let’s say the share price of our target investment is $10 the first month, but drops to $8, then $6, and then $5 in subsequent months. In the fifth month, the price gains back a little lost ground, finishing at $8 per share. Simple math — adding the monthly prices and dividing by our five months — gives us an average price per share of $7.40 over that five-month span.
Now let’s say we had chosen to invest $500 each month in that particular investment. At the previously stated prices, we would have purchased a total of 357 shares over the course of our five-month time frame. With a total investment cost of $2,500 — our $500 monthly investment multiplied by five months — our shares only cost us an average of $7 per share.
The price fluctuations could have caused us to stay on the sidelines when the price was high, buying only in the months where the price was lower.But in this example,we actually came out ahead by using a consistent approach in our investing. By following a set strategy, we were able to weather the highs and still take advantage of the lows. So if you’re interested in an investment approach that offers a simple, systematic method, and allows you to avoid the emotion of “timing”the market, you may want to consider dollar-cost averaging. (Brian Hepp is a financial consultant at A.G. Edwards & Sons, Inc. Member SIPC. He (310) 453-0077 or at)
Originally published in the Santa Monica Daily Press print edition on July 27, 2006. Read the original PDF.