|
 FINANCIAL
PLANNING FIB #7
Dollar cost averaging is a very popular strategy
with financial planners and clients. It involves investing a
lump sum of money over a period of weeks or months to get a
better overall entry price than putting all the money straight
into the market.
The easiest way to see how it's supposed to work is with an
example.
Let's say that Bill Bloggs wants to invest $2,000 in ABC shares.
If he buys in March when ABC's share price is $10, he will receive
200 shares (i.e. $2,000 / $10). If instead he spreads his purchases
over the course of the year, assuming ABC's share price moves
as shown, he would end up with 240 shares at a lower average
price of $9.375.
How
Dollar Cost Averaging is supposed to work
|
| Month |
Amount
Invested
|
ABC
Share Price
|
No.
of shares
|
| March |
$500
|
$10.00
|
50
|
| June |
$500
|
$12.50
|
40
|
| September |
$500
|
$5.00
|
100
|
| December |
$500
|
$10.00
|
50
|
| TOTAL |
$2,000
|
$9.375
|
240
|
|
By anyone's standard, that's a pretty impressive result. The
only problem is that you need share prices to decline, on average,
for the strategy to work. And as any long-term chart of the
stock market will show you, share prices usually go up, not
down.
Unless you are very good at predicting weak share markets, it's
generally better to buy now rather than spreading your purchases
over six or nine months when average prices are likely to be
higher. It also makes life administratively easier for your
accountant when only have one CGT cost base rather than half
a dozen.
How
Dollar Cost Averaging usually works
|
| Month |
Amount
Invested
|
Average
Share Price
|
No.
of shares
|
| March |
$500
|
$10.00
|
50
|
| June |
$500
|
$10.20
|
49
|
| September |
$500
|
$10.64
|
47
|
| December |
$500
|
$10.87
|
46
|
| TOTAL |
$2,000
|
$10.43
|
192
|
|
|
|
