Dollar cost averaging
We’re going to let you in a little tip to deal with investment amid the current economic shenanigans. A different perspective if you will….It’s called, dollar cost averaging. I can hear you all yawning already but stay with me, just for a tick and ask yourselves these questions:
- Investment markets go up and down, right? – check
- Aren’t a lot of people terrified that they have invested/will invest their money and the value might go down – that’s what the newspapers say isn’t? – check
- If the value goes down, haven’t I lost my money – check [welllllll.. not necessarily]
What is Dollar Cost Averaging?
Dollar cost averaging basically involves an initial investment followed by regular contributions at regular intervals. The value of investments in growth assets go up and down based on a range of things. At the moment it all seems to depend on things like Barrack Obama’s haircut or how likely the rest of the world thinks it is that poor old knackered Greece will be able to repay their national debt !
What this means is that as markets go up and down, the price of investments changes. So it logically follows that if your overall investment principle is sound and after you make your initial investment contribution then at times when the market is rising, you get a lower number of shares or units in an investment for your regular contribution but the value of what you bought originally also goes up.
Now stay with me here because we’re at the good bit…….This also means that when the market is falling(en) that you get a greater number of units for the same investment. “You’re an idiot!” I hear you say but like I said, stay with it.
The extra good bit or the cherry on top of all of this is that if you buy an investment in a down period at a lower price and hold it and the market goes up, you have to be better off on that portion when the market goes up.
Check out the simple scenario below:
I invest $1000 up front and then $100 each month. I sweat, I choke on my cornflakes, I curse my fund manager, I yell at the cat and I vow never to do it again while the market tanks in a 2008 GFC type crash. But, I stay in. I then ride the market back up again to find that I have still made a net gain, despite the fact that the market price of a unit of investment has not returned to its original value at the time I invested.
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