If you are looking for an investment strategy that offers simplicity, with a long-term approach, this
technique may be right for you.
Choosing an investment strategy that suits you is never easy. You face a myriad of tough questions,
including:
- How much money should I invest?
- How often should I invest?
- Where should I invest my money?
Fortunately, there's a venerable investment strategy that could be the answer to many of your concerns. It's called Dollar Cost Averaging, and it can simplify your investment planning.
The name may sound complicated but, simply put, Dollar Cost Averaging is nothing more than the
systematic investment of a fixed dollar amount at regular time intervals. For example, you could invest
$100 every week. Or $500 every month. Or $1,000 every three months. The amount and frequency of
your investments depends upon your financial means and long-term goals. However, once you initiate
the plan, the key to success is sticking with it and ignoring market fluctuations.
How Does Dollar Cost Averaging Work?
Basically, Dollar Cost Averaging attempts to take the ups and downs of the market and "smooth them
out." Instead of trying to time the highs and lows (a daunting task, even for professionals), you're
investing the same amount of money at regular intervals. Dollar Cost Averaging encourages a systematic approach to investing that frees you from trying to time the market. Let's take a look at how a Dollar Cost Averaging program would work under three hypothetical market environments: fluctuating, rising, and declining.
Dollar Cost Averaging in Turbulent Times
Let's assume you decide to put $100 every month in an investment that is currently selling for $10 per
share. (For this hypothetical example, let's assume that there are no additional charges). The first
month you invest $100 and receive 10 shares. Then, in an extreme but easy to follow example, the
market falls and the price drops to $5 per share. In the second month your $100 buys you 20 shares.
The market rebounds in the following month, the price jumps to $10 per share, and for your $100
investment you receive 10 shares. Let's see where you would stand:
|
Fluctuating Market
|
|
Regular
Investment
|
Share
Price
|
# of Shares
Acquired
|
|
$100
|
$10
|
10
|
|
$100
|
$5
|
20
|
|
$100
|
$10
|
10
|
| Total: |
$300
|
$25
|
40
|
Average Share Cost To You: $7.50 ($300 ÷ 40)
Average Share Price Over 3 Months: $8.33 ($25 ÷ 3)
As you can see, you now own 40 shares after a total investment of $300. The average price is $8.33,
but the average cost to you was $7.50. Being disciplined and remaining with the program is the key to
the long-term success of Dollar Cost Averaging.
In Good Times...
Let's say you continue with your investment program, and the market rallies. Your investment
rises to $20, then $25, and eventually $50 per share. Let's see where you stand.
|
Rising Market
|
|
Regular
Investment
|
Share
Price
|
# of Shares
Acquired
|
|
$100
|
$20
|
5
|
|
$100
|
$25
|
4
|
|
$100
|
$50
|
2
|
| Total: |
$300
|
$95
|
11
|
Average Share Cost To You: $27.27 ($300 ÷ 11)
Average Share Price Over 3 Months: $31.67 ($95 ÷ 3)
When the market rises, you benefit in two ways: the value of your total investment increases
(obviously), and the average cost you paid is lower than the average share price (not so obvious, but
true). When you compare the average share price ($31.67) to what you actually paid ($27.27),
you can appreciate the benefits of Dollar Cost Averaging.
... And In Bad
It's tough to find a silver lining in the dark cloud of a declining market, but through the consistency of
Dollar Cost Averaging, you can take some consolation. Let's assume the market begins to slide
and the price drops to $25, then $20 and eventually $10 per share.
|
Declining Market
|
|
Regular
Investment
|
Share
Price
|
# of Shares
Acquired
|
|
$100
|
$25
|
4
|
|
$100
|
$20
|
5
|
|
$100
|
$10
|
10
|
| Total: |
$300
|
$55 |
19
|
Average Share Cost To You: $15.79 ($300 ÷ 19)
Average Share Price Over 3 Months: $18.33 ($55 ÷ 3)
Here, when the share price fell from $25 to $10 you were able to purchase the greatest number of
shares. In addition, your average share cost ($15.79) was less than the average share price. Because
you invested a fixed dollar amount at regular intervals, ignoring the price fluctuations, you were able to
purchase a larger number of shares when the price was low and a smaller number of shares when
the price was high. In effect, you are buying a lot at bargain prices, and relatively little at what might be
considered exorbitantly high prices.
No Guarantees in Life
As illustrated in the "declining market" example, Dollar Cost Averaging does not guarantee a
profit nor protect against loss. If you have to "sell low," no system is going to give you a gain. It's
every investors dream to "beat the market," but unfortunately there are no magic methods that can
guarantee that. However, a Dollar Cost Averaging plan can offer a disciplined, systematic approach
to investing, that could be the cornerstone of your long-term planning. Since such plans involve
continuous investment in securities regardless of fluctuating price levels, you should consider your
financial ability to continue making purchases during periods of low price levels.
Setting Up a Dollar Cost Averaging Plan
While Dollar Cost Averaging may simplify the questions "How much?" and "How often?"
you should invest, before you can enjoy the benefits of this program you must first answer the
question, "Where should I invest?" Investing in variable products is a popular way to utilize Dollar
Cost Averaging. Vehicles such as mutual funds, variable annuities, and variable universal life
insurance offer investment flexibility and convenience. You can set up a customized program where
you invest a fixed amount at regular time intervals into a variable product. Your regular investments
can be made by simply writing checks, or you can take advantage of the convenience of bank
drafting. With this method, automatic payments are withdrawn from your bank savings or checking account to purchase shares on a regular basis.
Contact Us Today
A NYLIFE Securities Inc. registered representative — professionally trained and experienced — can help you analyze your needs and recommend appropriate solutions — at no charge to you. For assistance, contact a representative for a prospectus, which contains more complete information including charges and expenses. Please read the prospectus carefully before you invest or send money. Securities offered through NYLIFE Securities Inc.(Member FINRA), 51 Madison Ave., NY, NY 10010.
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