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Ask WomensFinance? : Answer |
Q: I've heard so much about
dollar-cost averaging. How does it work?
A: One of the most effective ways
to invest in mutual funds and build your nest egg is through dollar-cost averaging -- also
known as automatic investing. This technique is a great way to start investing if you
don't have a large sum of money to invest or you simply want to add some consistency to
your investment plan.
Using this strategy, you invest a fixed amount of money at regular intervals, usually
monthly. By doing this, you purchase more shares when prices are low and less shares when
prices are high. So your average cost per share may be less than your average price per
share -- you'll profit from this difference plus any increase in share price.
By spacing out your investments at fixed intervals, you'll also protect yourself from the
swings of the market. Emotionally, you won't have to worry about timing your investment
decisions -- or overcoming the fear of investing at the peak of a market.
The following hypothetical example shows $600 invested over six months. It assumes a
fluctuation in share price with regular investments made on the first of each month.
Date |
Invest |
Share Price |
# of Shares |
Total Shares |
| 1/1 |
$100 |
$10.40 |
9.615 |
9.615 |
| 2/1 |
$100 |
$9.20 |
10.870 |
20.485 |
| 3/1 |
$100 |
$8.45 |
11.834 |
32.319 |
| 4/1 |
$100 |
$9.75 |
10.256 |
42.575 |
| 5/1 |
$100 |
$11.05 |
9.050 |
51.625 |
| 6/1 |
$100 |
$9.40 |
10.638 |
62.263 |
Average Cost Per
Share:
Total Amount Invested $600
Total Shares Purchased 62.263
= $9.64
Average Price Per
Share:
Total Prices Per Month $58.25
Number of Months
6
= $9.71
The average cost is less than the average price by $.07 -- you have a built-in profit.
Your mutual funds will grow if you remain committed to dollar-cost averaging. But you have
to be a disciplined investor for this strategy to work best. This means staying invested
for the long-term, taking advantage of share price fluctuation, and making fixed
invesments at regular intervals each month.
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