Saturday, August 13, 2011

The Argument for Dollar Cost Averaging

I've heard a lot of talk recently about Dollar Cost Averaging in the last year, though I hadn't seen the numbers. First of all, a short explanation on DCA. The idea is to put the same amount of money into your stock account every month (or week, quarter, year), no matter what. The reasons are:
  1. It helps you remember to put money in regularly, and moving toward your retirement.
  2. With a promissory letter to the fund, you can start with lower amounts than normally needed - some ask for $5,000 minimum OR $200 a month.
  3. If the fund is going up and down, you'll buy more shares (same overall cost) in down months.
I didn't really get the power of #3, and I'm a number person, so I decided to see for myself. The following took about 10 minutes to throw together in Excel, and is really indicative of the power of DCA.

Invest $50 a month









Fund price

Amount

Shares



$20.00

$50.00

2.50



$19.00

$50.00

2.63



$18.00

$50.00

2.78



$17.00

$50.00

2.94



$16.00

$50.00

3.13



$15.00

$50.00

3.33



$14.00

$50.00

3.57



$13.00

$50.00

3.85



$12.00

$50.00

4.17



$11.00

$50.00

4.55



$10.00

$50.00

5.00

50% loss


$11.00

$50.00

4.55



$11.00

$50.00

4.55



$11.00

$50.00

4.55



$12.00

$50.00

4.17



$12.00

$50.00

4.17



$13.00

$50.00

3.85



$13.00

$50.00

3.85



$13.00

$50.00

3.85



$14.00

$50.00

3.57



$14.00

$50.00

3.57



$15.00

$50.00

3.33



$15.00

$50.00

3.33



$15.00

$50.00

3.33

still down 25% after two years
















Totals

$1,200.00

89.09









$13.47

Price per share



$1,336.34

Current value



$136.34

Profit !




22.7%

ROI




This is based on the fact that I started with $0 and ended with $1,200 invested, so on average had $600 in the market. How would that look - at the end of 2 years and a 25% decline in stock price to be up almost 23%? On the other hand, a steady increase in stock prices and your gains lag, since you keep buying stock at higher and higher prices. And it only helps you lose less on a steady decline.

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