DAILY FINANCIAL TIPS – DAY 38 – DOLLAR COST AVERAGING
These daily financial tips are designed to be short ideas covering different aspects of family and business finances. They are short pieces intended to provide information to enable individuals, families and businesses to make informed financial decisions. Not all tips will apply to every situation, but over the course of a year, most financial topics will be covered. Check in regularly and share with friends and associates.
One of the most effective ways to invest and to take advantage of market fluctuations and volatility is the concept of dollar cost averaging. This is a particularly effective strategy for younger investors (works for all age groups). The concept is to commit a specified amount of money on a regular basis (ie monthly) to invest. By investing regularly, you are investing in all market conditions, both increasing and decreasing markets. This has the effect of lowering your overall average cost. I’ll illustrate below:
Assume you invest $100/month over a 5 month period into Mutual Fund ABC. Over the 5 months, Mutual Fund ABC value fluctuates as follows: Month 1- $20, Month 2 – $16, Month 3 $12, Month 4 $17, Month 5 $23. So over the 5 month period, you’ve purchased the following Mutual Fund shares: Month 1 – 5, Month 2 – 6.25, Month 3 – 8.33, Month 4 – 5.882 Month 5 – 4.348. At the end of the 5 months, you’ve purchased 29.814 shares of mutual fund ABC. You’ve invested $500 which over 5 months is now $685.74.
The effectiveness of this strategy is the discipline and regularity of making regular investments (ie Monthly). Over time, small investments will grow significantly. The illustration above does not factor in additional dividend or interest income or long term capital appreciation which further magnifies the growth.
While this strategy is particularly effective for investing, it has many other uses to diversify and minimize risk. Similar to ‘don’t put all your eggs in one basket’ analogy or the pitfalls of trying to time markets with your investments.
Share these ideas with friends and family and come back to check out daily financial tips and ideas. If there are subjects you wish covered or questions, please email me and I’ll include them in future posts.