Dollar Cost Averaging

Dollar cost averaging is a technique whereby an investor puts a fixed amount of money into the same investment vehicle at regular intervals. For example, if Ian invests $500 a month into a mutual fund every month, he is dollar cost averaging. Dollar cost averaging offers a number of benefits. For many investors, the habit of investing regularly is a difficult one to develop and maintain. Setting aside the same amount of money from each paycheck is a good way to develop this discipline. Many mutual fund companies can arrange automatic deductions from your checking or savings account which make it even easier to invest regularly. You’ll soon find that you hardly miss the money which is going to build a steadily increasing investment nest egg.
Dollar cost averaging also increases the rate of return on your investment dollar. Here’s how it works. Suppose Ian invests his $500 a month into a mutual fund whose net asset value per share varies between $20 and $40. During months when the NAV is lower, Ian’s $500 will enable him to buy more shares; when the NAV is higher, he’ll buy fewer shares. The beauty of dollar cost averaging is that, over time, by investing the same amount each month, Ian will buy more shares at a relatively lower price. Therefore, his average price per share will be lower, meaning that his investment profits will be greater.
See Table 8-2 for an illustration of how this works. Over the year shown, with the NAV of Ian’s Fund F varying between $20 and $40 per share, the average NAV is $30.08 per share (calculated simply by adding the average monthly NAV — $20 in January, $24 in February, and so on — and then dividing the sum by 12). But Ian has been able to buy a total of more than 208 shares for $6,000. Thus, the average per share price Ian has actually paid is just $28.83 — more than a dollar less than the average NAV for the period.
Dollar cost averaging always works this way: By buying more shares when the price goes down, you reduce your per-share purchase price and so stretch your investing dollar. Dollar cost averaging enables the investor to regard a decline in NAV not as a loss of value but rather an opportunity to buy more fund shares at a discount price. I strongly recommend it to all new investors — and to experienced ones who’ve never enjoyed its benefits.