Dollar Cost Averaging

by Lawrence Lee on February 27, 2009

During my presentation with my client, I will always introduce the concept of Dollar Cost Averaging.

What is Dollar Cost Averaging?

Dollar Cost Averaging is investing a fix sum of money at a regular interval (e.g. monthly or weekly) in a financial instrument (stocks, unit trust or shares), regardless of its price at the intervals.

In my definition, Dollar Cost Averaging is buying more units or shares when the price is low and buying less units or shares when the price is high. It works very well in both down market or up market. Especically in these tough times, indexes around the world do not move much and is constantly at a low. It is time to start investing now when  prices is low.

How Dollar Cost Averaging Works?

If you invest in a particular unit trust, you will buy more units when the price is low and buy or units when the price is high. Please see illustration below,

Month Amount  Price  No of Units
1  $1,000  $ 1.00 1000
2  $1,000  $ 0.50 2000
3  $1,000  $ 0.20 5000
4  $1,000  $ 0.80 1250
   $4,000   9250
Average Price Per Unit  
   $4,000  =   $       0.43

This is a losing money scenario. You started to invest at $1.00, but at the end of 4th month, the value of the unit trust has gone down to 80 cents. If you were to invest in a lump of $4,000 at $1.00, the value of your unit trust at the end of 4th month will become $3,200, you have lose $800 straight. But if you invest steadily in the unit trust, (like in the illustration) you will actually have a gain of $3422.50 (9250 units x [0.80-0.43]). On top of that your principle still remains at $4,000. In total you will have $7,422.50 instead of $3,200. 

Will you change the way you investing by switching to dollar cost averaging method? Well its up to you to decide.

Comments on this entry are closed.