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What Is Dollar-Cost Averaging?

Dollar-Cost Averaging:

Dollar-Cost Averaging is the technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high.

Eventually, the average cost per share of the security will become smaller and smaller. Dollar-cost averaging lessens the risk of investing a large amount in a single investment at the wrong time. With Dollar-Cost Averaging, there is always "Good News". If market goes up, your account is worth more. If the market is down! No problem. Next month, you will get more shares at a lower price when the $50 or $100 comes out of your pay check or checking account

Dollar Cost Averaging Example

Look carefully at the table. If you are investing $1000 a year, consider the case explained in the table:

Year

You

Invest

Share

Price

Shares

Purchased

Cumulative

Shares

1

$1,000

$10.00

100.000

100.000

2

$1,000

$5.00

200.000

300.000

3

$1,000

$7.50

133.333

433.333

In this example, your average cost per share is $6.92 ($3,000 / 433.333 shares). But the price per share is $7.50. So although it looks like you should have simply broken even, you actually made money because you bought more shares at the lower prices. The value of the shares is $3,250 (433.333 * $7.50).

By always investing the same amount of money, you are purchasing more shares when the price is low and fewer shares when the price is high. It is important that your average cost per share should be lower than your average price per share. However, it is not a guarantee of success. Dollar cost averaging is not going to help a lousy investment turn a handsome profit! But it does makes investing very, very easy.