Dollar cost averaging explained
Written by R. A. Stewart
If you do not know what dollar cost averaging is and how you can use it as part of your investment strategy then you may have come to the right place.
I may not be a financial whizz but can at least explain things in simple to understand terms.
Dollar cost average is when you invest in a particular company regularly. If you invest in PGG Wrightson, a farming retailer every month for a set period of time; that is Dollar Cost Averaging and the reason why this is so is because the average price you paid per share will be somewhere between the highest price and the lowest price.
It is not considered dollar cost averaging if you purchased shares in different companies every month because the idea behind the dollar cost averaging system is that you purchase shares regularly in a particular company; they could be up and down on the date of purchase and the average price paid per share is between the highest and the lowest price.
Here is an example.
You decide to purchase shares in xyz company every month for six months.
It’s share price is as follows:
January $3.00
February $2.90
March $2.80
April $2.70
May $2.60
June $2.50
Here is the formula for working out the average:
Step 1-Add up the totals paid per share:
$ 3.00
+ $ 2.90
+ $ 2.80
+ $ 2.70
+ $ 2.60
+ $ 2.50
= $16.50
Step 2-Divide the figure in step 1 by the total number of transactions. (6)
$16.50 divided by 6.
The answer is $2.75
Notice the difference in price paid per share in January and the average price paid per share. That is averaging at work.
If you bought a different share every month, that would not be called averaging because you could have bought the share at a high or a low, it would be down to chance.
You could however, just purchase unit trusts in a managed fund using the averaging strategy. That is called averaging using the steps given above.
Using the averaging strategy helps to take the emotion out of your decision making. It is investing mechanically because you already know how much you are investing and where you are investing every month.
Hopefully I have explained everything clearly enough.
About this article
The information here is of the writer’s own opinion and may not be applicable to your circumstances. You are welcome to use the article as content for your blog/website or ebook.
Www.robertastewart,.com
