|
 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
|
|
|
|
