Dollar cost averaging is an investing technique which lowers market risk by purchasing a set amount of securities at regular intervals. Many investors might be able to save themselves effort by starting an investment plan. Here you can learn the three-part process to starting a plan for dollar cost averaging, see solid examples of how it can reduce the cost basis, and find out how it might reduce risk.
Dollar Cost Averaging: What is it?
The investor slowly invests in lower amounts over an extended length of time instead of all of his assets at once. This spreads the cost basis out over years, which safeguards against any changes in the market price.
Set Up Your Own Plan
Three steps must be followed to begin the dollar cost averaging plan:
Determine a fixed dollar amount that you can afford to invest monthly, and keep that amount consistent. If this amount varies, the plan may not be as successful. Choose an investment, such as index funds, that you would want to hold on to for 5 to 10 years or more. Invest that fixed amount into your chosen security at regular intervals, such as weekly, monthly, or quarterly. Consider an automatic withdrawal plan if your broker offers one.
An Example of a Dollar Cost Averaging Plan
You want to invest $15,000 in common stock as of January 1, 2000. You can do two things: invest as a lump sum all at once and forget it, or begin a dollar cost averaging plan and get into the stock slowly. You decide to invest $1250 quarterly for three years.
In January 2000, you would have bought 264.46 shares at $56.72 each. In December 2002 when your stock closed, it was at $13.69 and your shares would have been worth $3620!
However, with dollar cost averaging over three years, you would own 746.21 shares. In December 2002, your holdings would be worth $10,216. Now the stock must go up only $20.10 to break even, as opposed to $56.72. Also consider that under the dollar cost averaging plan, when the stock hit $56.72 you would have made a profit of $27,326!
You can find out more information including tips and strategies that will get you right on track when investing by watching this informative video about the Australian Share Market.
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