Introduction to Dollar-cost Averaging

Dollar-cost averaging is a systematic investing technique used to accumulate shares of stock or a mutual fund over many month or years. You invest a specified amount of money to buy shares at a regular interval, say each month, and then you hold them for the long term.

As the stock price moves up, a specified dollar amount purchases fewer shares but when the stock price moves down, you buy more shares. The average price per share is computed by dividing the total cost of all shares by the number of shares. Thus, you dollar-cost average.

Typically buy-and-hold investors use dollar-cost averaging in retirement accounts and dividend reinvestment plans and fund the purchases with payroll deductions or automatic debits from a bank account. All large mutual funds and many brokerage accounts allow automatic investing.

How does Dollar-cost Averaging Work?

Here is a simple example of dollar-cost averaging. Suppose you invest $100 each month to buy shares of a stock. The following table shows five monthly purchases at different prices and the resulting number of shares and their value.

Dollar-cost Averaging
Date	Price per Share	$ Invested	# Shares Bought	Total # Shares Owned	Total $ Value
March 1	$50	$100	2.000	2.000	$100.00
April 1	$52	$100	1.923	3.923	$204.00
May 1	$58	$100	1.724	5.647	$327.54
June 1	$56	$100	1.786	7.433	$416.24
July 1	$61	$100	1.639	9.072	$553.41

After five purchases the total amount invested is $500 and you own 9.072 shares. Therefore, the average cost per share is $55.11 ($500/9.072). As of July 1, the 9.072 shares are worth $553.41.

Dollar-cost Averaging for 3M

3M (MMM) investors, who started dollar-cost averaging purchases of $100 per month in January 1976, realized a peak value of $427,658 in June 2004 for a $34,200 investment. As of February 13, 2006 the value was $359,106 for a $36,200 investment.

These returns resulted from a systematic long-term investment plan that coincided with an increasing stock price. Clearly, dollar-cost averaging made enormous sums of money for these 3M shareholders.

Conclusions and Recommendations

Be careful with dollar-cost averaging. It works when prices are on the upside. But if you make repeated purchases on the downside and prices keep falling, you will lose money. Be particularly cautious with individual stocks of poorly-managed companies or stocks whose prices have increased rapidly. These stocks can quickly decline from very high prices to very low prices. For cyclical stocks take your profits when prices are high.

For more information about dollar-cost averaging read Dollar-cost Averaging: Not Always a Good Decision