Dollar Cost Averaging:
The Big Sum Strategy

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Dollar Cost Averaging can be the big bucks-fetching strategy when you master the techniques involved. The practice of buying a fixed dollar amount of a certain investment, irrespective of the share price on a regular schedule can be termed as dollar cost averaging. However, more shares are purchased when the share prices are low, and lesser shares are purchased when prices are high. Dollar Cost Averaging reduces the risks involved in investing a bigger amount in a single investment at the not-so-right time. Subsequently, the average cost per share of the security reduces over a course of time. In the UK, it is known as “pound-cost averaging”.

Dollar cost averaging can also be defined as an investment strategy structured to lower volatility, in which securities like mutual funds are purchased at fixed dollar price at predetermined time period. It is also referred to as ‘constant dollar plan’.

Investors can save a lot of time, effort and money by beginning to follow the dollar cost averaging practice. It lowers an investor’s cost basis and reduces risks in investments tremendously.

Dollar Cost Averaging – Points to ‘Stock’

The best aspect to follow while investing is to observe the history of investing and investments of the past, analyze the trends and then plunge. And, the few things that need to be kept in mind are -

• Plan in advance the investment amount, keep it consistent.
• Identify and choose the investment that you would like to hold for long.
• Invest the money into the security you have chosen and fix regular intervals for the same - weekly, monthly or quarterly works best.
• Buy smaller amounts of shares over a longer period of time.
• Spread the cost basis over several years and manage risk against market changes.

Dollar Cost Averaging – Steps to Win

As discussed earlier dollar cost averaging is a systematic technique that reduces market risk with the purchase of securities at predetermined time and amount. Therefore, setting up your own dollar cost averaging is an important aspect in the whole investment plan.

Smart investing in stocks and bonds includes management of risk in a well planned manner. For any stock, bond, mutual fund or other investments an individual purchases, there are three distinct risks one needs to pay attention to.

Elimination of Risk in Dollar Cost Averaging

The three major risk factors are – Business Risk, Valuation Risk, and Force of Sale Risk.

Business risk in dollar cost averaging – Is the most common risk that accounts for risk due to loss of value through competition, financial insolvency, mismanagement, etc. Industries sensitive to such risks include airlines, railroads, etc. Unlike commodity type businesses, companies that have good franchise value can raise prices by way of adjustment to increased labor and material cost, etc., to cope with such a risk.

Valuation Risk – It involves risk associated with value of a company. The danger of investing in companies that appear overvalued is that there is very little risk for error. But there will be significant decrease in the value of its stocks, even if there is a slight slide in the sales of its products for a quarter. Therefore, for a given price to the company stock, its value needs to be judged.

Force of Sale Risk – Here you need to realize when your stock is going to appreciate when you invest. After you identify a good company, which is selling far below what it is really worth, buying a good number of shares, you have bet on when your stock is going to appreciate. This is a financially fatal mistake. In the stock market, you can be relatively certain of what will happen, but not when. If it’s January, and you plan on using the stock to pay your April tax bill.

Dollar Cost Averaging – Lessons from the Past

For any investment there is a certain degree of risk factor involved. By avoiding or minimizing the risks, a better return on investment on stocks can be achieved. This can help you withstand the temporary fluctuations in the financial markets and protect yourself from any financial disasters.

Follow a plan in dollar cost averaging to succeed in your investments:

If you have to invest $15,000 in the common stocks of company xxx on January 1, 2000– you could either invest the money wholly or you could work out a dollar cost averaging plan by segregating the investment for three quarters, say $1,250 per quarter. At the end of 2002, at the closing of the stocks, your holdings would not have been too worth. The advantage here is that with dollar cost averaging, coupled with the low cost basis, the profits are more when the stock hits a certain price. With dollar cost averaging you could even reach a better break-even. You could even combine the power of Dollar Cost Averaging with the diversification of a mutual fund. Dollar cost averaging is the best asset allocation decision for retirees.

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