Dollar Cost Averaging, Again


I can’t stress enough how the concept of cost dollar averaging can help you to invest smarter. I found this article from Ric Edelmen’s email that is very motivating and informational. If you only read one article about investing in a year, here’s the one that you should read:

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How Dollar Cost Averaging Works
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Say you have $100 and you buy a stock that costs $10 per share. That means you buy 10 shares. Next month, you save another $100, which you place into the same fund, only now the shares are just $5. Thus, you buy 20 shares. What’s the average price of all your shares?

If you said $7.50, you’re wrong.

 

You invested $200 ($100 per month over two months) and you own 30 shares (you bought 10 shares, then 20). Divide $200 by 30 shares and you’ll find that the answer is $6.67.

Why did you think the answer was $7.50?

Because you used the arithmetic mean ($10 + $5 divided by 2 = $7.50). But I used the harmonic mean ($200 divided by 30). Thus, we’re both right — the average price is $7.50, but the average cost is $6.67. Since the harmonic mean always produces a lower number than the arithmetic mean, you have a built-in profit!

 

Painting-TravellingDollar cost averaging succeeds because you buy fewer shares at higher prices and relatively more shares at lower prices. To make it work for you, simply invest a specific amount of money at a specific interval. Perhaps $100 per month, $25 per quarter or a $3,000 IRA each year. It does not matter as long as you are consistent. Be sure to invest at each interval, regardless of what the stock market is doing at the moment.

 

In fact, dollar cost averaging helps you overcome your fear that you’ll invest at the top of the market. If you had invested $1,000 in the S&P 500 on January 1 of every year from 1965 through 2002, you’d have earned an average annual return of 10.2%. But if you got really lucky and were able to make your investments on the one day each year when prices were at their lowest, you’d have averaged 10.9% instead. But, knowing your luck, it’s more likely that you’d have picked the worst day to invest each year. If so, your average annual return would have been 9.8%.

 

As you can see, it doesn’t much matter when you invest when you dollar cost average. It only matters that you do invest and that you stay invested. "Timing" doesn’t matter — "time in" does.*

~excerpt from the Truth About Money by Ric Edelman

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  1. #1 by mal-qatar on April 28, 2009 - 3:16 am

    What about compounded interest(CI)??
    Does UT also has this CI in addition to DC??

  2. #2 by mal-qatar on April 28, 2009 - 3:18 am

    What about gold investment?
    What are the advantages/disadv. compared to UT??

  3. #3 by nikz on April 28, 2009 - 11:15 am

    gold investment and UT share the same concept of investment (return generate from the price gain)..the different is gold investment doesnt hv dividend/distribution. so it doesnt giv u annual income as UT did.

    how return been generate:
    gold investment
    1. capital growth (price gain)

    Unit trust (UT)
    1. capital growth (price gain)
    2. dividend/distribution

    • #4 by mohd basir ahmad on June 6, 2009 - 4:00 pm

      similar. Capital Gain (CG) contributes to the increase in Nett Asset Value in both.

      Distribution tak increase NAV in variable-priced UT (lain la dgn fixed-priced UT macam ASB, coz ASB hanya bergantung pada dividend (bukan CG).

      if UT doesnt have distribution, price akan jadi RM30 seunit. nampak mahal, sebenarnya tidak.

      different, gold – commodity. UT – collection/pool of money to invest eithjer in equity, bond, money mkt, REIT and what have you.

      advantages/disadvantages: panjang cerita, it depends on.. your investment objective – apa sebenarnya lu mau. “invest in gold” mmg didengar lebih glamour but thats not the case here.

      Rgds
      mohd basir ahmad
      agency manager – PM
      017-3355733

  4. #5 by Kak Naan on April 29, 2009 - 9:53 am

    Hi Irwan,
    I’m glad you’re back to write about investment. I guess it must be typo-error. It is ‘Dollar Cost Averaging’.

    • #6 by Irwan on April 29, 2009 - 2:00 pm

      lol kak naan, thanks for spotting it for me. Good to have you back here. I’m graduating this May. It’s gonna be exciting. It’s kinda end of era, for formal education.

  5. #7 by kaklong on May 13, 2009 - 3:58 am

    This is an interesting concept. hope to learn more from you! =D

  6. #8 by CHONG KONG HUI on May 7, 2010 - 4:45 pm

    DCA is NOT the magic formula. It must be works hand-in-hand with proper Asset Allocation in order to archieve optimum return.

    Say the stock market is already high for no reason, are you still using DCA to buy more equit-related unit?

    If market is suffer distress and most stock price falls, are you still using DCA to buy into income-related unit?

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  9. #11 by Bryan on May 4, 2011 - 3:47 pm

    Hmm, interesting article. I didn’t think about doing dollar cost averaging using the harmonic mean.

Comments are closed.