While there are different philosophies regarding the effectiveness of dollar cost averaging, the general technique is designed to gradually build your portfolio by making regular, set dollar amount investments at predetermined intervals. For example, you may invest $100 the 5th of each month or $300 the first day of every 3rd month. Instead of investing one lump sum the investor purchases smaller amounts over a longer period of time.
Getting Started with Dollar Cost Averaging
To begin your dollar cost averaging plan, you must do the following:
- Determine how much money you are able to invest and whether or not you will be able to stick with the plan.
- Select an investment (e.g. stock, bonds and mutual funds) that you plan to invest in for the long-term. (I.e. five years or longer.)
- Determine the frequency of your investments. Some common options include weekly, monthly or quarterly though some investors contribute annually when they receive their tax refund. (To be consistent it is recommended that you arrange for direct deposit as a payroll deduction or from your bank account directly.)
In the example below, an investor has contributed $1,250 per year:
|
Invest date
|
Amount
|
Price per share
|
Shares purchased
|
|
Jan. 1997
|
$1,250
|
$56.72
|
22.04
|
|
Jan. 1998
|
$1,250
|
$11.64
|
107.39
|
|
Jan. 1999
|
$1,250
|
$31.34
|
39.27
|
|
Jan. 2000
|
$1,250
|
$22.60
|
53.31
|
|
Jan. 2001
|
$1,250
|
$22.10
|
56.50
|
|
Jan. 2002
|
$1,250
|
$19.05
|
65.62
|
|
Jan. 2003
|
$1,250
|
$18.13
|
68.95
|
|
Jan. 2004
|
$1,250
|
$16.14
|
77.45
|
|
Jan. 2005
|
$1,250
|
$14.58
|
85.73
|
|
Jan. 2006
|
$1,250
|
$8.66
|
144.34
|
|
Jan. 2007
|
$1,250
|
$54.19
|
23.07
|
|
Total
|
$15,000
|
$20.10 avg.
|
746.21 shares owned
|
Suppose the date is January 1, 1997, and you have $15,000 to invest. You have two options: you can either invest the full $15,000 or you can set up a dollar cost averaging plan and contribute $1,250 annually. If you contributed the full $15,000 on January 1, 1997, you would have only been able to purchase 22.04 shares for every $1,250. Now notice in January 1998 when the cost per share went down to $11.64. Because you used dollar cost averaging, you were able to buy 107.39 shares for the same amount of money as you spent on 22.04 shares in 1997. This is the power of dollar cost averaging. At times you are able to buy more with less.