Going back to the example in the Dollar Cost Averaging post:
For example, Greg is a new investor with $1000 to invest, and wants to put all his money into shares of company X but is concerned about the risk he is exposed to by investing his hard earned money all at once. He heard about the Dollar Cost Averaging strategy and its applicability towards new investors which prompts him to make a schedule of buying shares of company X over a set period of time rather than all at once. He decides to set a fixed schedule buying $250 worth of shares at the beginning of every month for four months. An example scenario is outlined below to compare the outcomes of the dollar cost averaging strategy versus a lump sum investment into shares of company X based on possible price movements and disregarding transaction costs:
Average Cost/Share $21.80 Average Cost/Share $25
Current Stock Price $23/share
Current Position Value $1055 Current Position Value $920
Note: The changes in stock price used above are for illustrative purposes only. In reality, such large price fluctuations in a stock price are quite rare and unlikely to happen over a short period of time absent any fundamental changes to the company’s financial health and strategy.
Using the CRM2Plus software, we can show the investments in the above example graphically.
Dollar Cost Averaging Strategy:
graph generated from CRM2Plus
Lump Sum Investment:
graph generated from CRM2Plus
In the above example, we can clearly see that Greg was able to acquire more shares of company X stock with the Dollar Cost Average strategy compared to putting the entire $1000 into shares all at once at the beginning of the first month. After purchasing stocks at the beginning of Month 4, the value of his position in company X stock will be $1055 under the Dollar Cost Average strategy compared to $920 if he had put all his money into shares of the stock in the first month. Overall, this type of investment strategy is more conservative when prices are volatile, and it allows investors to ease into the market over a period of time at a pace they are comfortable with. With less exposure to risk, Dollar Cost Averaging is a more disciplined approach for novice investors.
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