SolveYourProblem
Article Series:
Learn Stock Market Trading Tips
Dollar
Cost Averaging: Reduce Market Risk
The measured purchase of securities and stock
at predetermined levels is called dollar cost averaging. This
practice may be something you, as an investor, are already
doing without realizing it. Rather than investing a large sum
of money at one time, dollar cost averaging plans work
to slowly buy smaller amounts of stock over a longer period
of time.
This way the cost is spread out over several years and protects
investors from changes in market price.
Dollar cost averaging eliminates having to play the risky
game of market timing. In other types of investment strategies,
you wait until your desired company has a low stock price meanwhile
hoping that the stock will increase in value. You do not want
to invest in stock that is on its way down, yet at the same
time you don’t want to buy high only to have to sell low later
on. Determining when to buy your stock and find the bottom
of a price swing is complicated and based on speculation. Dollar
cost averages removes the hassle and presents a solution for
longer-term gains.
Dollar cost averaging works by investing a fixed amount into
a security or stock per pay day or month, regardless of the
stock price. In bull times and bear times, you buy your stock
at the market price.
Many are unaware, but 401(k) plans operate on this same principle.
Defined contribution plans such as 401(k) and 403(b) plans
use dollar cost averaging to build retirement funds. Each pay
period, the employer takes a certain amount of your salary
before taxes and deposits in one or more accounts. These accounts
are often mutual funds or annuities.
Dollar
cost averaging also helps take the emotion out of playing
the market. The established amount comes out of your account
regardless of the market price. You simply let the market fluctuate
as it will, and you invest your money regularly.
There
are three simple steps to setting up your own dollar cost
averaging plan. First you must decide exactly how much
money you can afford to invest each month. Decide on this figure
carefully because this is an amount that you need to be able
to contribute to your plan on a long-term basis. It is okay
if you want to increase the amount later, but for the time
being pick an amount that is manageable for a long period of
time. Secondly, you need to select an investment that you want
to hold for the long term. Ideally, you want to hold this investment
for five to ten years, or perhaps longer. Pick something that
has been around for a while such as a well-established company
or an index fund.
The third step in the plan is making investments into the
security that you’ve chosen. This is done on a weekly, monthly
or quarterly basis. It is best to set this up as an automatic
withdrawal if possible.
For example, let’s say you choose to invest $300 per month
for six months. The first month, the shares are $5 so you are
able to buy 60 shares. The next month shares are up to $10
and you purchase 30. The third month shares are $6, and the
fourth they are $12. In the fifth month of your investment
plan shares are $10 and in the final sixth month they cost
$5 per share again. Over this six-month period, you are able
to buy a total of 255 shares for $300 per month. The average
price of the share during this time it is $8 when you divide
the combined costs of individual shares by the number of months
($48/6). However, with your dollar cost averaging, you only
paid $7.05 per share when you divide the total amount spent
by the total number of shares purchased ($1800/255).
The price fluctuation is exaggerated in this example to show
how the process works. The benefit of using dollar cost averaging
is that you don’t have to guess when the shares will be at
a low price. With traditional investing toward the example
above, you might have avoided investing during the second,
fourth and fifth months or you may have hoped that the $12
per share was a sign that the share would be rising soon.
Over a long period of time (in most cases much longer than
six months) dollar cost averaging helps the individual
investor gain powerful leverage in the market. With a dollar cost averaging
plan, you can get a better price than guessing when to buy. # # # # # SolveYourProblem.com : 2007
> Home > Stock
Trading: Main Page
|
