Dollar Cost Averaging: What is It and When Does It Pay to Use It?
Dollar Cost Averaging. What is it and when does it pay to use it? First off, in our business, we love acronyms so for DCA, it is dollar cost averaging. Basically it's a strategy that allows an investor to buy the same dollar amount of an investment in regular intervals.
So, for instance your 401K. Let's say you're contributing to that every week or two weeks, depending on your pay cycle. Each time you make that investment, it's a set amount, for example twenty-five dollars to fifty dollars per pay period, however, you'll be buying different level of shares.
Let's look at some examples:
First example, let's say if you start with a lump sum. You have ten thousand dollars to invest, fifty dollars share price, two hundred shares owned. Pretty simple. But of course with investing, what happens when you sell it? So here I show three scenarios, forty, sixty, and eighty dollars. As you see at forty, of course, that would be a loss because you bought it fifty and then at sixty and eighty you would have profits. Now you see the two hundred shares so let's now look at a flat market. Hello. Where are we right now and 2018 to May 2019, flat. No question about it.
Let's take that same ten thousand dollars. Split it up into four different transactions. Fifty dollars, forty dollars, sixty dollars and fifty dollars. Now in this scenario you own two hundred and four shares. Sell it. Strike price, forty, sixty, eighty. Two losses and then a profit on the last one.
So let's look at a falling market. Ten thousand dollars, split it up, fifty dollars, forty dollars, thirty dollars and twenty-five dollars. So now, as you see, we've accumulated two hundred and ninety five shares, which is pretty good. Same investment, more shares to sell at forty dollars, sixty dollars, and eighty dollars, all scenarios are profitable. That is obviously a good time to do this.
Let's look at a rising market. So after a cycle, you had the crash, you're doing the same thing. Split up, four transactions, fifty dollars, sixty-five dollars, seventy-five dollars and eighty dollars. As you see, in this scenario, we only buy one hundred and fifty five shares. Again it's all about owning those shares. And, as you see, similar scenario, worse loss, flat at sixty dollars , strike price, and then eighty, profit but obviously not as strong.
So conclusion, we showed you four different scenarios, a falling market is the best time to really utilize this strategy. So if you're a new investor start doing it this way. Now if you're in a 401K, continue it, but obviously you should have some type of strategy to put something on the sidelines, if the market breaks and if you want to know about that click on our latest market update. So, dollar cost averaging, DCA, great strategy in certain markets, okay strategy in others.