DOLLAR COST AVERAGING
A no-fail investment strategy
Dollar cost averaging is a strategy for investors who are unsure which way the market is heading. (And let's face it, that's all of us!)
It is a technique that consists of regularly placing a fixed sum of money into the same investment. By doing this, you will always be purchasing units at an average cost which is lower than the average unit price over the entire period.
As an example, you put $2,000 a year for five years into a market linked investment. During that period the market falls by 80% before recovering to its original starting point. At the end of the five years your position would be:
| |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
|
| Investment |
$2,000 |
$2,000 |
$2,000 |
$2,000 |
$2,000 |
| Unit price paid |
$10 |
$4 |
$2 |
$6 |
$10 |
| Units bought |
200 |
500 |
1,000 |
333 |
200 |
As you can see, your total outlay was $10,000. You now own 2,233 units at $10 each with a total value of $22,330.
Accordingly, your investment has appreciated by 122% at a time when the market has been in a slump.
The average cost of your 2,233 units was $4.40 a unit. ($2,233 x $4.40 = $10,000.) However, the real average unit price over the same period was $6.40.
How does dollar-cost averaging work?It works because if you keep up your regular investment you get a larger number of units as the price falls. Accordingly, you're able to acquire your biggest parcel at the bottom of the market, and make your first profit on the largest number of units when the market eventually rises.
Remember, very few people know the right time to enter and leave a market. Certainly, there are plenty of predictions made, and many boast about the time they picked their entry and exit perfectly. However, you seldom hear about the other times when they get it wrong.
The advantages of the dollar-cost averaging process is that it's simple, it works, and it enables investors to do well in a rising or falling market.
However, this technique will only work if prices eventually recover after a downturn. Accordingly, we recommend that you only use dollar-cost averaging for top quality investment. History shows that the sharemarket always recovers to a position greater that its previous best.
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