Dollar Cost Averaging

Dollar cost averaging is the method of investing in a particular stock/fund at regular intervals. It suits a buy and hold investor. This provides insulation in a volatile market.

For example, if you decide to invest $1200 in a company whose stock price is $100, instead of buying 12 stocks on a single day, you spread your investment over a predetermined period of time, say 12 months. Each month you would buy that company stocks worth $100. Popular opinion is that irrespective of how the market moves, the investor should invest the alloted money in the company. This might not be suitable in all situations.

An illustration of how dollar cost averaging could provide insulation in a downward trend.

At the end of the 1 year period, if the investor used dollar cost averaging, the value of the 17.6 stocks is about $792. If he did not use dollar cost averaging, the value of the 12 stocks would only be $540. Also in order to break even, i.e., the total value of the equity to be $1200, the stock value has to increase to $68.19 which is about 51.5% growth with dollar cost averaging. Without dollar cost averaging, the stock value has to rise back to $100 which is a 122.22% growth.

If the value of the stock was rising instead of falling…

At the end of the 1 year period, if the investor used dollar cost averaging, the value of the 9.6 stocks would be $1486. If he did not use dollar cost averaging, the value of the 12 stocks would be $1860. This is a situation in which investing using dollar cost averaging does not provide as much profit as one without dollar cost averaging.

But this is a technique to be used when the market is volatile, i.e., the investor does not know which direction the market is going to go or when the stock price is wavering up and down too much. Personally, I would use dollar cost averaging since I am just a beginner. And this method would help me to start slow and grow without losing track of my investing goals.