Dollar cost averaging is really a very simple method of investing.  I will give a very simple example to illustrate the concept.

 

For example, every month you set aside $60 to buy chocolate bars (sorry ah folks, I love chocolate! Just bear with me).  So your record shows:

 

30 bars at $2 per bar in the first month

20 bars at $3 per bar in the second month

6 bars at $10 per bar in the third month

15 bars at $4 per bar in the fourth month

60 bars at $1 per bar in the fifth month

120 bars at $0.50 per bar in the sixth month

 

So by the end of 6 months, you have a total of 251 bars of chocolate at an average cost of $1.43 per bar.  The total amount you have spent is $360.

 

When you apply this concept to investing, you will use the same amount of money every month to buy shares.  If the price is low, you get more.  If price is high, you get less.  

 

So the average price of shares is equal to: Your total cost divided by your total number of shares.

 

Are you happy with my simple explanation? 

 

If not, please read Dr Malkiel’s explanation:

 

“Periodic investments of equal dollar amounts in common stocks can substantially reduce (but not avoid) the risks of equity investment by insuring that the entire portfolio of stocks will not be purchased at temporarily inflated prices. The investor who makes equal dollar investments will buy fewer shares when prices are high and more shares when prices are low.”

 

As Dr Malkiel stated, this method reduces the risk of you using all your money to buy when the price is high.

 

In the above example, if you use $360 to buy chocolate bars when the cost is $10 per bar, you will only get 36 bars.

 

Conversely is also true, this method prevents you from using all your money to buy when the price is low.  If you use $360 to buy when the cost of chocolate bar is $0.50, you will get 720 bars.

 

So is dollar cost averaging investment method for you?

Please ask yourself the following questions:

1. Are you able to save your money consistently?
2. If yes, do you have the time to watch the market every week, every month?
3. Are you able to control your emotion and buy ONLY when the price is very, very low?

 

If you answer YES to all the 3 questions, then dollar cost averaging is not for you.  It will in fact hinder you from getting more shares.

 

Please look at our example above.  If you want to catch the price, there are only 2 months that the cost of chocolate bar is lower than $1.43. 

 

So folks, before you commit to dollar cost averaging, please take an honest look at yourself.  Anyway, your profits from your investment do not come only from your cost price.  It also depends on your selling price.

 

Using dollar cost averaging, you may not be able to buy at the lowest price.  But you can time your selling.  Sell only at a much higher price than $1.43.

 

So folks, happy investing.  You know what I love to eat.  Correct!  It’s chocolate.  Do send me a ton of chocolate bars when you make tons of money.