Dollar Cost Averaging – Average By Name
Dollar Cost Averaging – What You Need to Know Now
There are many myths in the financial services industry. Myths that sound good at first, but on closer inspection have so many holes you’ll be swimming, not rowing your boat ashore.
Two of the most popular are that you have to “be in a share for 7-10 years to see a good profit”, or “the Market cannot be timed”. At face value, these market-isms seem like good advice – truly, your brain says “Yes, I DO have to be in a share of 7-10 years before I will see a profit!” But when you really look at a share – I mean really look at it, you will see that all of its growth happens in 14 months and then it goes no-where for the other 6 years. (Once you realize this, then the real magic starts to happen in your trading account).
But all that aside my personal favorite – and the most dangerous myth of all is Dollar Cost Averaging.
An Average Way to Invest
Dollar Cost Averaging is when you invest a certain amount of money into a fund or share portfolio on a regular basis. It is another way of saying a “Regular Savings Plan”, but putting it into investments. As an example, it would be if you took your hard earned $100 down to your broker, invested it, and then invested another $100 every month, no matter where the market was.
And that’s the idea – Dollar Cost Averaging is used to get around “the market can’t be timed” myth. If you’re investing a regular amount on a regular basis, surely it will all even out in the end, right? Well… let’s see for ourselves with two examples – Johnny and Sue.
Johnny will put $100 a month into a share ABC, and Sue puts $100 a month into Share XYZ. This is what it looks like:
|
|
Johnny |
Sue |
||
|
Total Invested |
Share Price |
Balance |
Share Price |
Balance |
|
$100 |
$12.00 |
$100 |
$18.00 |
$100 |
|
$200 |
$13.00 |
$207 |
$17.00 |
$194 |
|
$300 |
$13.50 |
$315 |
$16.00 |
$282 |
|
$400 |
$14.00 |
$427 |
$15.00 |
$365 |
|
$500 |
$14.50 |
$542 |
$14.00 |
$440 |
|
$600 |
$13.00 |
$586 |
$14.50 |
$556 |
|
$700 |
$12.50 |
$663 |
$15.50 |
$694 |
So there you have it – Johnny’s share went up and then corrected, leaving him with almost 10% less money that if he had had it in the bank. Sue’s share went down quite a way, but even as the market pulled back up it wasn’t enough to make the money back that she had lost. As you can see, Sue still ended down 1% – interest in the bank makes more than that.
I guess the point here is that markets DO fluctuate, and yes, markets DO trend, often in predicable ways. If we can invest only when the market is trending up (with a high probability), we will be much better off than either Johnny or Sue. And the good news is it does not take that much more effort achieve.
At the end of the day you really should consider if Dollar Cost Averaging is right for you. And also consider this – many of the market greats did not use Dollar Cost Averaging. Paul Tudor Jones had a sign saying “Losers Average Losers” at his trading desk – he focused on shares they knew would go up with a high probability and left the rest by the wayside. In fact I’d doubt if your stock broker even used it himself. After all, he’s got commissions to earn.
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June 11, 2009
Tags: Money Management Posted in: Articles On Building Wealth
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