Dollar Cost Averaging
Sometimes, just reading the
headlines can make one dizzy. One day the market is up 200 points, the next day
its down 150. XYZ Corp. rose 15 points in one day, just to see it back down 14
the next. And so it goes, up and down, back and forth. Is it a bull market or a
bear market? Should I be in or out? What is an investor to do? Especially one
who does not have a large inheritance to speculate with, but who is trying to
build a portfolio to provide for a comfortable retirement fund.
Remember, there are no guarantees
in equity investing. The 100% sure winners are often, anything but. For many
would be investors, the answer to "How do you make a small fortune in the
stock market?" is "you start with a big one." There are a number
of strategies that can be employed to try and smooth out the bumpy ride that
Wall street can provide investors. One such widely followed technique is known
as "dollar cost averaging."
This is not to suggest that such
a strategy is in itself foolproof and a guarantee of financial success and
profits . You still have to make wise stock selections and keep abreast of
corporate developments to insure that the selection is still a bona fide
long-term holding. What dollar cost averaging can accomplish, especially for the
investor building a portfolio through periodic investments, is a convenient
manner in which to increase holdings in specific stocks and to at the same time
take advantage of market fluctuations.
Dollar cost averaging means
making periodic investments of the same amount of money in the same stock
regardless whether the price is declining or ascending. The drill, as with
stop-loss orders, must be that the called for action is virtually automatic. The
same dollar amount of investment will be made in the same security on the 15th
of every month, or on the first day of every quarter or whatever interval is
selected. The investment must be devoid of any consideration of the current
stock price, if the investor wishes to maintain a program of dollar cost
averaging.
Should the investor decide that
there should be an opportunity for him to veto the investment at the time of
purchase, then he is resorting to a different strategy known as "dollar
cost finagling" and that is a separate topic.
As previously noted, dollar cost
averaging is probably best suited to the investor who is starting to build a
portfolio and does not have sufficient funds to purchase a meaningful number of
shares in several companies. Through a periodic investment program, though, the
investor can put a given amount each month in a list of companies and obtain the
benefit of not only building a sizable investment fund over time, but also of
obtaining a range of prices, some higher some lower, that would provide a lower
average cost over time.
As with any other aspect of
investing, there are no guarantees that this will produce cost benefits. Some
studies that have been done on simple investment plans have not provided
conclusive evidence and there are too many variables to simplify any in-depth
analysis. However, there is evidence that for the investor that has the capital
to make a significant one time investment in a company, there may be no benefit
to dollar cost average the investment. However, for the small investor, the
discipline demanded by dollar cost averaging may be the greatest benefit. And as
in other aspects of life, discipline is essential for good behavior!
