Thursday, 21st October 2010

Dollar Cost Averaging

Written by George Traganidas Topics: Stock Investing, Wealth Building

A lot of people are trying to time the market, but very few are able to do it consistently. The old advice of buy low and sell high is not that easy to implement and many people end up doing the exact opposite. An easy way to invest in the stock market is dollar-cost averaging. Here is a helpful post from fool.com that explain how it works:

Let’s begin with a definition. Dollar-cost averaging is a fancy term for periodic investments of fixed sums of money. Simply put, dollar-cost averaging involves investing a set amount of cash ($100, $500, $1,000) at regular intervals (monthly, quarterly, yearly) into a stock, a group of stocks or a fund. The key to its success is consistency. Investing the same amount each time on a set schedule can really help grow your portfolio over time.

Why’s it a good method?

Dollar-cost averaging is good for so many reasons that it’s difficult to know where to start. For one thing, investors who may not have a big chunk of green saved up to plunk down into the market can still gain the benefits of owning common stocks. You can still buy shares and build positions in solid companies without waiting until you have a big wad of money to invest all at once.

Another positive is that dollar-cost averaging means you aren’t trying to time the market (and we definitely don’t recommend market timing). Instead, you’ll be adding money to the market when it swoons and when it sings.

While other investors might be fretting about the market’s fall, you’ll be resolute in your investing, knowing that this month, just like last month and the month to come, you are going to be getting into the market. Don’t abandon dollar-cost averaging in the market’s darkest hours.

Why? That brings us to perhaps the greatest characteristic of dollar-cost averaging. It can help you smooth out volatility in your portfolio, and can even lead to a lower overall cost basis for your investment than if you had just bought shares all at once. With dollar-cost averaging, when a stock goes down, your fixed investment will buy you more shares, and when it climbs, you’ll be buying fewer.

Now, obviously, there’s no guarantee that dollar-cost averaging will always result in a lower cost basis and better returns. There’s no investing scenario out there that can promise that. As with anything else, dollar-cost averaging involves risk. It’s a tool, not a perfect fix, even though it can be incredibly effective.

Now a word about fees and commissions. In order to get the greatest benefit from dollar-cost averaging, it’s critical that you keep your expenses in check.

If you’re only contributing $50 a month and paying $10 in commissions each time, you’re not doing yourself any favours. In this case, the money you’re shelling
out for the transaction is out of proportion to the money left over for the investment.

To make dollar-cost averaging a success, keep expenses and trading costs (fees, commissions, etc.) for your dollar-cost averaging investments down to less than 2%.
Anything higher and you’re better off saving up the money for more infrequent lump sum dollar-cost averaging investment. Perhaps one new stock every three months would work.

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