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Dollar Cost Averaging can give you an investment strategy that evens-out the fluctuations in the price of an investment made over time. It works by purchasing the same dollar amount of shares at regular intervals. It is most commonly used to purchase mutual fund shares on a regular basis. We will cover the following in this tutorial:
WHAT IS DOLLAR COST AVERAGING?
Dollar cost averaging is the practice of purchasing the same dollar amount of shares of an investment each period. When the price is up, you buy fewer shares. When the price is down, you buy more shares. It is usually advised to make the payments on the same day each period.
This differs from buying the same number of shares each time. Let us explain this with some examples. Imagine instead of Dollar Cost Averaging that you choose to buy 100 shares on the 15th day of every month for four consecutive months. Assume the share prices were the following on the 15ths of these months:
| Date | Price/Share | Shares | Cost |
| Jan 15 | $3 | 100 | $300 |
| Feb 15 | $5 | 100 | $500 |
| Mar 15 | $10 | 100 | $1,000 |
| Apr 15 | $4 | 100 | $400 |
| Total | 400 | $2,200.00 |
| Avg. Price Per Share | | $5.50 |
By dividing the total amount you paid ($2200) by the number of shares you purchased (400) you find that the average price is $5.50 per share.
Now let's examine what happens when you invest a set amount of dollars each month.
AN EXAMPLE OF DOLLAR COST AVERAGING
If you invest the same amount of money as the previous example over four months, you would invest $550 on the 15th of each month. You get the following:
| Date | Price/Share | Shares | Cost |
| Jan 15 | $3 | 183.333 | $550 |
| Feb 15 | $5 | 110 | $550 |
| Mar 15 | $10 | 55 | $550 |
| Apr 15 | $4 | 137.5 | $550 |
| Total | 485.833 | $2,200.00 |
| Avg. Price Per Share | | $4.53 |
You purchased 485.833 shares with your total investment of $2,200. By dividing $2,200 by 485.833, you arrive at an average price of $4.53 per share. This is a savings of 97 cents per share from the $5.50 per share in the previous example. You purchased more shares for the same investment.
You can see that when prices are low, you can buy more shares. Conversely, when prices are high you will buy fewer shares. Thus, when it comes time to receive dividends, you will have more shares on which you can earn dividends.
By using a little more math, you can see your savings in another way. Read below to find out how.
FORMULA FOR FIGURING PRICE PER SHARE AND COST PER SHARE
With the following handy formula, you can compare what you would have paid per share using different investment strategies. In fact, this is the same simple formula we used in the previous two examples to compare the results of buying a fixed number of shares per month compared with purchasing a fixed dollar amount of shares per month.
You can determine your average price per share (what you paid) with this formula:
| Average Price = | Total Amount You Paid |
| Numbers of Shares Bought |
As you should recall, using dollar cost averaging the average price per share was $4.53 compared with purchasing the same number of shares each month which resulted in an average price per share of $5.50.
Dollar Cost Averaging gives you an advantage because it helps reduce the average price you pay. This is true because the Dollar Cost Averaging method takes advantage of the fluctuation in price.
CLOSING REMARKS
Dollar cost averaging is a simple and straightforward method of investing. It is often an attractive option for the investor who wants to systematically contribute to their investment portfolio over time. By electing to Dollar Cost Average, you can help reduce some of the risk that poor timing and potentially adverse price fluctuations will have on your investment decisions. Using the Dollar Cost Average method, it is not as likely that you will purchase too much of a particular security at a time when it is priced relatively high in the market.
This concludes our section on Dollar Cost Averaging.
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