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You are here: Stocks Investing Guide >
Mutual Funds > Dollar Cost Averaging |
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Dollar Cost Averaging
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One of the major
benefits of buying shares in a mutual fund instead
of investing in real estate or buying a high-yield
CD is that you can start investing with a little
bit of money and keep adding to it down through
the years. One of the best ways to invest in
stocks or a mutual fund is called "dollar cost
averaging" (or "DCA), because you don't have to
buy a hundred shares at a time, or even five; you
buy what you can afford each time.
In dollar cost averaging, you set aside a sum each
month that will go into an account at your
broker's. With that sum, on a certain day of
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the month, the broker
will purchase as many shares or portions of shares as
the amount will cover.
This is a great method for buying
shares not only because it lets you control the amount
of money you spend each month, but because as the prices
of shares move up and down, your money buys more or
fewer shares at a time. Now, if the share prices
continued to move down and down for many months, you'd
have something to worry about, but if you choose a
decent fund, sometimes the shares will drop a little and
more often will gain a little. Dollar cost averaging
means that, every time you spend a hundred dollars on
shares and the price is low, you will get to buy more of
them, so that when the price goes up, you will then own
more shares at a higher value. When the price on shares
goes up, your hundred dollars will buy fewer shares that
month, which is fine because who wants to buy a lot of
shares when they're at their highest? So, dollar cost
averaging puts a natural control on your money that
allows you to buy more stock when the price is low and
less stock when the price is high.
People who are new to investing may find it strange
that, instead of owning 25 shares of Proctor & Gamble,
they will own 24.3 shares, but dollar cost averaging
also means that with whatever money you put into the
fund each month, you can buy percentages of shares if it
doesn't come out even. Your monthly statement will show
you the price you paid for your shares and the share
price, any commission paid and how many shares you've
accumulated, what you've paid for them and their market
value up to the day. It's a nice thing to see, like
coins filling up an old pickle jar, as your number of
shares increase over time and your nest egg grows.
When you buy shares in a mutual fund, you pay the price
of the fund's net asset value (NAV) as calculated at the
end of that day. The NAV is the total of the mutual
fund's investments and cash, minus fees and other
liabilities and then divided by the total number of
shares. And with dollar cost averaging, you feel smart,
because you inevitably buy more shares when the price is
low, and fewer shares when the price is high, without
even having to consult a crystal ball.
The main reason that dollar coast averaging works so
well is because it forces small investors to make a
commitment that might not otherwise be made. It's hard
to save up $2,000 at $200 a month, just to put it into a
mutual fund at the end of the 10 months, and many people
plan to invest but get waylaid by the tricks life plays
when the money's waiting in the bank or in the coffee
can under the bed. Some people will claim that you'll
earn more money using DCA over lump-sum investing, but
that's not particularly true: if you have the discipline
to save up lump sums and then buy shares when the prices
are at their lowest, you'll probably do a little bit
better. But, if your fund if a well-managed one, the
fluctuations in price probably won't be that large
anyway. DCA is good because once you dedicate a certain
payment directly and automatically from your checking
account to your broker's account, inertia may keep you
from stopping the payments, which will keep your
investment growing. That coffee tin under the bed is
just too easy to get to when you want a new pair of
shoes or a trip to the racetrack.
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How to stick to a household budget
and have extra
money for investing
1. Customize your budget with your current needs, wants and future goals in mind.
2. Try to think if your budgeting plan as a "spending" plan rather than penny pitching.
3. Sit down and rationally discuss budget goals and spending limits with your spouse. You are bound to disagree somethere, but it important to take the time to find common ground.
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