On any particular day, it is virtually impossible to determine if it is a good time to invest money in the stock market. We believe that "market timing" is not the best strategy to use to invest your money. Market timing allows investors to believe they are getting the best price at the current time. Only time will tell if the best price the market has to offer was truly received by the investor. Very few investors make money while trying to time the market, and many have failed using this strategy. Market conditions are prone to change at any time. In today's market, gains or losses can be tied to current events that may have little or no bearing on the economy or a company's prospects. We recommend that investors use dollar cost averaging to invest in stocks over a period of time.
Dollar cost averaging (DCA) is a method of investing a fixed dollar amount on a specific date every month over a long time period. This type of investing allows equities to be purchased as the market fluctuates. Therefore, purchases are made when prices experience their highs and lows. To examine the benefit of dollar cost averaging, look at the following examples of two investments. One is a fixed dollar amount, while the other is a fixed number of shares invested each month. We assumed that the investor had a mutual fund purchase of $100 per month over four months. The cost of the mutual fund and share amounts were as follows:
Month |
Amount per Share |
Total Paid |
Shares Received |
January |
$20 |
$100 |
5 |
February |
$10 |
$100 |
10 |
March |
$25 |
$100 |
4 |
April |
$20 |
$100 |
5 |
The total amount spent was $400 ($100 x 4), and the total number of shares purchased was 24. Therefore, if we divide $400 by 24 shares, the average cost basis per share is $16.66.
Now, assume that a monthly purchase was made in fixed share amounts rather than dollar amounts over the same four-month period. We assumed the investor decided to purchase 10 shares each month over four months. The cost
per share and total cost of each purchase were as follows:
Month |
Amount per Share |
Total Paid |
Shares Received |
January |
$20 |
$200 |
10 |
February |
$10 |
$100 |
10 |
March |
$25 |
$250 |
10 |
April |
$20 |
$200 |
10 |
The total amount spent was $750 ($200 + $100 + $250 + $200), and the total number of shares purchased was 40 (10 each month for 4 months). Therefore, if we divided $750 by 40, our average cost basis per share was $18.75.
The individual, who invested $100 per month, benefited from dollar cost averaging a fixed dollar amount over a four-month period by reducing their average cost per share to $16.66. This is also known as the break even point. Dollar cost averaging works, because the investor purchases equities at different prices over several months. By investing a fixed dollar amount at regular intervals, the investor bought more shares, when the price was low and fewer shares when the price was high. Therefore, the investor received more shares for the money.
Below is a chart showing the benefit of dollar cost averaging over the best decade of the S&P 500 Index and through the Great Depression.
| |
Return on Investing
$10,000 at Once |
Return on Investing
$1,000 per Year |
Difference |
Best Decade (1949-1958) |
20.10% |
19.20% |
= -0.90% |
Great Depression (1929-1938) |
-0.92% |
7.00% |
= 7.92% |
Using lump-sum investing, the $10,000 investment was only 0.90% ahead of investing $1,000 annually during the best decade (1949-1958) of the stock market. The $1,000 annual investment had a very nice 10-year return of 19.20%. During the period of 1929-1938, the Great Depression, lump-sum investing speaks for itself. The lump sum investment of $10,000 had a loss over a 10-year period, while dollar cost averaging $1,000 annually had a 10-year return of 7% beating the lump-sum method by 7.92%. While regular investing does not protect the investor against loss in a declining market, investors should invest continuously during periods of fluctuating markets. For more information regarding this topic, please contact
The Henssler Financial Group at 770-429-9166, or comments@henssler.com.
