Dollar cost averaging helps you take advantage of market downturns.
Here's how it works:
Over time, mutual fund prices go up and down. If you invest a sum of money in a mutual fund on a regular basis, say $25 a month for a year, you have 5 important advantages:
When your fund value is going up, you purchase a certain number of units.
Advantage: you continue to contribute to a winning fund.
When your fund value is going down, the unit price of your fund goes down too, so you are now buying even more units for your $25.
Advantage: you're getting a bigger piece of the pie in the form or increased units. Investors call that "buying low."
You stay invested.
Advantage: you leave your investments alone and let them benefit from the potential growth.
Because the stock market goes up and down, your unit price may average out to be lower than it would be if you invested an equalivalent lump sum at one time at the beginning of the year.
Advantage: more value for your money.
Smaller investments on a regular basis can be easier than one large lump sum.
Advantage: convenience with fewer sacrifices.
Regular Contribution vs. Lump Sum Investing
Example: Initial cost of fund units is $10, a price that goes up and down - as high as $15 and as low as $6 over the year, and returns to $10 at yearend.*
Gaining More from Regular Contributions
Pre-authorized contribution at $25 a month
Lump sum at beginning
Total invested over a year
$300
$300
Total number of units purchased
33.5
30
End value of portfolio
$402
$360
Gain/How much your investment made
$102
$60
Average cost per unit
$8.95
$10.00
What Pre-Authorized Contributions Buy Each Month
Date
Unit Price
Dollars Invested
Units Purchased
Jan
$10
$25
2.50
Feb
$12
$25
2.08
Mar
$9
$25
2.78
Apr
$7
$25
3.57
May
$12
$25
2.08
Jun
$15
$25
1.67
Jul
$9
$25
2.78
Aug
$8
$25
3.13
Sep
$7
$25
3.57
Oct
$6
$25
4.17
Nov
$8
$25
3.13
Dec
$12
$25
2.08
* Note: if you were to invest a lump sum during a month when your unit cost is lower, say $6, then naturally you would have made a better deal. But we rarely know when that will be. So the best way to take advantage of the unpredictable ups and downs is to use the Dollar Cost Averaging technique.
