Dollar cost averaging strategy

For those of us who like to stay invested and not worry about the day-to-day price fluctuations in the market, we are more concerned with the long term picture.

Traders often try to time the market, and history has shown that is a very difficult thing to do, but staying invested often mutes out timing and focuses on the longer term of a company. Markets gyrate up and down, and typically overshoot to the upside or downside.

Fundamentals of a company matter, so does its future outlook. When you have a company that is here to stay in the long term, but the price is declining below your buying price, consider dollar cost averaging. That is always keeping money on the side to buy if the stock goes lower.

How to calculate the new average price

Take the shares you bought multiply it by the buying price, and then add to that total the amount you just bought at the lower price, and then divide it by the total shares owned. That is your new average buying price.

Lets say you bought 50 shares of AMD’s stock at $120. 120 X 50 = $6,000, but now the stock is trading at $100/share. You are not worried about the decline because you are interested in how AMD will be doing 5 – 10 years from now. At $100, you decide to buy 25 more shares… that would cost you $2,500. Now add 6,000 + 2,500 = 8,500, and divide 8500 by the new quantity of shares owned, which is now 75. 8500/75 = an average price of $113.33.

This strategy helps to lower overall cost of an investment, and in the long run can give you a nicer return as opposed to you not dollar cost averaging. Looking back at the example above, if the investors wanted to wait until AMD hit $200/share but never bought any stock at the lower price, the return is 66%. For the investor who bought more at the lower price, their return is now 76.5%, much nicer than the 66% if we had not done anything.

Set aside a certain amount each month to invest

Dollar cost averaging also can be that if you set aside a specific amount from your income and invest that amount each month (or any period of time). Say you want to set aside $500 a month to invest and you put that money into an index fund (smart thing to do). Instead of worrying about entry and exit points, you just invest that capital and just let it ride for years and years.

Over time the market has given great returns to patient investors. $500/month into an index fund typically return an average 7% a year. Keep reinvesting those dividends, and that will lead you to even nicer returns in the long run.