Tuesday, September 10, 2013

Dollar Cost Averaging



Although part of the “excitement” or “thrill” of investing is the idea of finding new stocks where to put our money; sometimes is perfectly okay to take the “safer” route and stick to what we know by slowly building a significant position in a company we feel strongly about. One way we can do this is via “Dollar Cost Averaging”.

In theory, dollar cost averaging refers to the technique of buying a fixed amount of shares of a particular company stock on a regular schedule regardless of the price. Source.

For example, lets say you found a stock you feel strongly about and you have $500 to invest in that particular stock. Instead of throwing in the entire $500  at once and hoping for the best; you commit to buying 5 shares of said stock every month for the next 6 months or so (depending on the current price of the stock).

Let’s illustrate with a company such as Disney (DIS).
Let’s suppose current price of Disney is $62
You have $500 to invest, which would buy you a little bit over 8 shares, at today’s price. (500/62=8.06)

Instead of throwing in ALL the money you have and acquiring all shares at once, you decide to buy two shares per month for the next 4 months (for example, 2 shares with your first paycheck of the month for the next 4 months).

The result? You will get DIS at different prices, averaging out your cost per share! What do I mean by this? Lets illustrate-- Say you buy at the following prices (hypothetically speaking):
September: 2 shares at $62

October: 2 shares at $58

November: 2 shares at $57

December: 2 shares at $65

 Your average price per share will be: 62+58+57+65/4= $60.25

So, basically, you’ll have 8 shares $1.75 cheaper than buying all at once! (Note: this may not seem like a lot but trust me, it is as it adds up overtime! And can be even more exponential with the more shares that you own, as you continue accumulate.)
Using this technique lowers your risk of buying too high and gives you the opportunity to get shares at a lower price in the event the stock does go down for whatever reason. It helps us get away from buying shares with “emotion” and we all know that when it comes to stocks is not a good idea to get emotionally involved. So, you’ll be buying while following your schedule and not because you had a “feeling” that it was a good day to buy.

As we all know, the stock market is NOT linear and share prices go up and down constantly.  Hence, you can take advantage of these “swings” by slowly building your position in the company of your choice. Not only are you averaging out your price per share but in addition, if the company pays dividends (as it is the case with DIS), more shares means you get more in dividends each quarter! Lets not forget about that amazing perk!!

Remember that this technique doesn’t come without risk. It works in our favor if the company is one to go up in price over time (most quality companies do). So, remember to continue doing your homework every week (check out Cramer’s post on the Golden Rules of investing if you missed it) and keep a close eye on the fundamentals. Remember that is never a good idea to just “blindly” throw in your money and hope for the best. This is not a black jack table.

So, as mentioned, even thought Dollar Cost Averaging may not be the “most exciting thing in the world” to do with stocks, it can be extremely profitable in the long term. This is a technique that is perfect for those risk adverse investors (those with a lower risk tolerance whom still look to make a nice profit without the fear and/or risk of loosing big).

Thanks for reading and Happy Investing!

If you have any questions you know what to do--- simply email me or comment below. Also, if you feel anyone you know may like this post, feel free to share!
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Disclaimer: I currently don’t own any shares of DIS but it is on my watch list. Don’t invest or cease to invest based solely on the information provided in this post.