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Poojan (Wagh) Blog

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The beauty of dollar-cost averaging | a bear market strategy

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MAJOR DISCLAIMER: I am not a financial analyst/expert, and I know nothing about stocks, markets, and money. If I did, I would have probably figured out how to monetize this blog. If you want real financial advice, seek a financial adviser.

Dollar-cost averaging is a phenomenon that occurs when you regularly invest the same amount of money in a stock no matter what happens. What tends to happen when you adopt this head-in-the-sand attitude is that when stocks are high, you end up buying fewer shares; when stocks are low, you end up buying more shares.

Note that the old adage of “buy low, sell high” is still the best you can do. However, (as Burton Malkiel points out), timing the market on these highs and lows is extremely difficult.

Here’s an example. Let’s say for 12 months, I invest in a stock. The first 6 months, the stock goes up, then returns to its initial price. The next six months, the stock goes down then returns to its initial price. Let’s say I invest $1 per month in the stock no matter what the price is doing. Here’s a table with the numbers:

month price shares purchased cumulative shares purchased average price total value gain/loss
1 1 1 1 1 1 0
2 1.1 0.91 1.91 1.05 2.1 0.1
3 1.2 0.83 2.74 1.09 3.29 0.29
4 1.3 0.77 3.51 1.14 4.57 0.57
5 1.2 0.83 4.34 1.15 5.21 0.21
6 1.1 0.91 5.25 1.14 5.78 -0.22
7 1 1 6.25 1.12 6.25 -0.75
8 0.9 1.11 7.37 1.09 6.63 -1.37
9 0.8 1.25 8.62 1.04 6.89 -2.11
10 0.7 1.43 10.04 1 7.03 -2.97
11 0.8 1.25 11.29 0.97 9.04 -1.96
12 0.9 1.11 12.4 0.97 11.16 -0.84
13 1 1 13.4 0.97 13.4 0.4

The thing to take away from this is that at the end of the 13th month, I have made some money. It may not seem like a lot of money, but the stock price did not go up; it’s exactly where it was when I started. In general (though not always), the stock market goes up over long periods of time (5-10 years), so I’ll be even better off than in this pessimistic (though timely) example.

Sure: I could’ve made more money if I sold all that I had during the 4th month (when the stock price was high), and then just waited until the 10th month (when the stock was low) to buy everything back. However: that would require a great deal of prognostication.

With dollar-cost averaging, I can make money withour requiring the stock to go up. Of course, if it goes down, I don’t make money–unless I keep investing and it eventually goes up.

Written by PoojanWagh

October 9th, 2008 at 12:58 pm

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