Dollar Cost Averaging is the way to go!
Posted: March 3rd, 2009 | Author: Mo2 | Filed under: Investing, Mutual Funds, Retirement, Stocks | Tags: Dollar Cost Averaging, Exit Strategy, Financial Freedom, financial plan, Investing, Investment strategy, MSFT, NASDAQ, stock market |In the investment world there are so many ideas and strategies, it’s often very easy to get lost in what to do. Dollar Cost Averaging is probably the most well known strategy and probably the easiest to implement into your investing style!
What is Dollar Cost Averaging?
Dollar Cost Averaging as its name suggests is where you buy a security over time to “average” the cost. So basically if you really like Microsoft’s stock (MSFT: NASDAQ) then you might buy a 100 shares today at $16. That’s a good start but a lot of us really don’t know what to do over the long run if the price goes up or down. If the price were to down to $13 you would buy a 100 shares and if the price shot up to $19 you would buy another 100 shares. By adding the three transactions together, you would have 300 shares for an average price of $16! So right there you would have a $3 profit on your 300 shares which would translate to $900 profit minus commission fees.
By having a Dollar Cost Averaging strategy, you predetermine how much you will buy of a stock. Some say that when doing dollar cost averaging you should alter the number of shares you buy, I would disagree because while this will help you buy the same amount every time, trying to buy odd lots of shares (anything less than a 100 shares) may make it hard to implement your strategy depending on the liquidity of the market that you are in. Stick to a set number of share and alter the price a little.
If you insist on investing a set amount of money, then put away the extra money when the market is low and use that money when the market is higher. If the market has gone up then add a little in of your own money to make up the difference. The key here is not to make sure you are putting the exact amount but that you are averaging your cost base.
Liquidity, by the way, refers to the ease of being able to buy and sell a security without having the price change too much.
Why Bother Using a Dollar Cost Averaging Strategy?
By implementing this strategy you can discipline yourself to buy the security even if the price is lower or higher. You should make sure that you are buying for the longer term and that you are also looking at a stable security that has a very little chance of going under. A great example would be a blue-chip stock such as a bank that you know will be around for a while (although some former big banks have gone under).
Exit Strategy
Buying is the easy part; it takes little effort except for coming up with the cash. Once you have accumulated enough shares and the stock is showing a nice profit, what do you do? Well to be honest, that’s entirely up to you. Well done for sticking to your plan and building it up so that you have turned a profit.
One thing you could do is to reduce your exposure to that stock and take out “just” the profits. You can use the profits and buy something else to start you dollar cost averaging strategy on that other stock. From there you can divide your contribution and invest in both stocks or alternate which stock you invest. This leads to the growth of your portfolio and you are well on your way to achieving a rewarding financial future.
Mo2 Thinks
Dollar Cost Averaging takes patience and discipline. It requires you to come up with a plan of what security to buy, how much to contribute and when to contribute. If you can stick these three factors, you will do well in the long run. As time passes and the market gets stronger, your cost base will look very good and you will be able to realize gains and possibly buy other securities or help yourself in your real life. I would recommend keeping your investments invested however and rely on your daily expense from your income from other sources.
You want to keep your investments alone until you really need them for something like a home purchase or retirement. These investments you make are what will help you realize financial freedom and you don’t want to slow that down just because you want to buy another jacket or a new bathtub. Stick to your plan, it’ll be worth it.
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