Investment Principles Everyone Should Know: No. 3 Cost Averaging

Labels: Basics, Personal Finance, Rules, Tips on Monday, October 13, 2008 at October 13, 2008

This series will present fundamental principles everyone, especially the young, should know when it comes to personal finance.

Cost Averaging

The aim of Cost averaging is to reduce the risk associated with a single, large investment by spreading out the investing (and risk) over time. Everyone has heard the adage, “buy low, sell high.” Seems simple enough, but in reality no one can predict exactly when the market will fall. By investing a fixed amount at regular intervals (weekly, monthly, etc.) regardless of share price, you will be able to maximize your total return assuming the investment follows an overall positive trend over the investment time frame (which is normally the case).

An example of this from youngmoney.com

“Dollar cost averaging works like this: systematic investments are made to an investment account. For this example we will say on a monthly basis. To keep things simple we will also say that the investment account is allocated 100% into one growth fund. We will use $100 as the monthly investment amount. Now, depending on how the market is doing that fund’s price is going to fluctuate from day to day. So let’s look at a six-month example in the table below.

Month	Price	Shares Purchased
1	20	5
2	16	6.25
3	10	10
4	5	20
5	10	10
6	25	4

In the example above, you have invested $600 and your account is now worth $791.73. Over the six-month period, you paid an average of $14.33 per share. If you would have taken all $600 and purchased the shares at the beginning of the six months, you would have purchased 30 shares and your account would now be worth only $750. For this example, using dollar cost averaging has increased your account by over 5%!”

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