Investing strategies: Dollar cost averaging

What is dollar cost averaging? (DCA for short)

You, as an investor have a set/fixed amount of cash you place on a single security every month or on a set schedule, the security can be a stock, bond, index or mutual fund, regardless of the security being up or down. In short, you purchase more shares when they are down in price and fewer shares when they are up in price. That way, you avoid "buying at the top of the market" but you also take advantage of purchasing shares at a cheaper price. Nonetheless, you invest regularly in the markets.

Example

Let's use one of my positions as an example, Visa. Every month I would place exactly $1,000 (or the fixed dollar amount) into the company from the beginning of 2017. 

Visa's share price (NYSE: $V)

Month 1: $82.71

Month 2: $87.94

Month 3: $88.87

Month 4: $91.26

Month 5: $95.40

And here are the number of shares my $1,000 would buy me every month. 

Month 1: $1,000/$82.71 = 12.09 shares

Month 2: $1,000/$87.94 = 11.37 shares

Month 3: $1,000/$88.87 =11.25 shares

Month 4: $1,000/$91.26 = 10.95 shares

Month 5: $1,000/$95.40 = 10.45 shares

A total of 56.11 shares by the end of the 5th month. As the stock price rises, the number of shares purchased decreases, minimizing the risk of "buying at the top of the market." 

I follow this strategy some more, but we suddenly find ourselves in a recession, and consumer confidence has decreased drastically. And remember, Visa makes money for every time you swipe their plastic card, so their balance sheet is looking a bit bad, and investors flee Visa's stock. Dropping it to $54.76 a share and it continues to fall for a while. 

Month 1: $54.76

Month 2: $50.82

Month 3: $49.67

Month 4: $46.23

Month 5: $45.81

But now suddenly, you're purchasing more shares with your $1,000

Month 1: $1,000/$54.76 = 18.26 shares

Month 2: $1,000/$50.82 = 19.66 shares

Month 3: $1,000/$49.67 = 20.13 shares

Month 4: $1,000/$46.23 = 21.63 shares

Month 5: $1,000/$45.81 = 21.82 shares

Our recession is over and Visa's stock price rises back to its 2017 highs of $95.40. As the price rose, the shares you purchased when Visa was at its lows, or the 101 shares you bought in month 1 - 5 during the recession, rose as well. Making your monthly deposit of $1,000 in those five months into ~$9,000. 

Check out an article from Modest Money on dollar cost averaging here. They further elaborate as to why it's better to invest on a scheduled basis rather than just a lump sum of cash. (Matter of fact, they explain DCA far better than I do here, do yourself a favor and head over there to learn about DCA)

Word of caution

Be advised, this strategy is best for the long-term. I highly suggest to distance yourself from individual stocks and place your cash into an index fund. The reason I recommend an index fund is because, historically speaking, indices have gone nowhere but up, individual stocks, they fluctuate. Take Sears as an example, the once dow 30 component who had this huge competitive advantage against other retailers, who did not face any danger of filing for bankruptcy and was thought to be "too big to fail" is failing and filing for bankruptcy protection. Had you held Sears for the past 20 years and DCA the living daylight out of it, you would have been in trouble. 

Sears stock.PNG

In comparison to an index fund, which tracks the overall performance of the market, is best suited for DCA. 

S&P 500 max.PNG