Dollar cost averaging
Over the years, I have had good luck with “Dollar cost averaging” as an investment strategy. Basically the idea is that instead of making one big one-time investment, break it into little bits over time. So, through the ups and downs of the market, the average buying price is lower.
At one point, I used to apply this principle whenever I could, such as buying gas. Instead of filling up the tank, I used to put $25 worth of gas every time I needed a fill, trying to capture more gas when price was lower and fill less when the price was higher. It is an easy way to pinch some pennies. I should get back to doing this again considering the current gas prices.
Anyway, the point of this post is to say that dollar cost averaging doesn’t work all the time. I came into some money last year and I wanted to put that in the kids’ college fund. Being a follower of dollar cost averaging, I decided not to make a purchase on one fine day in July 2010 and to make 12 purchases, twice a month from July to December.
After doing a retrospective analysis of this whole deal, it turned out to be a wrong decision. If I had plunked down all that money into one purchase in July, I’d have bought about 10% more shares as the stock market kept on climbing from July to December. The returns on this investment could have been 10% higher than what they are right now.
I think this example is just an exception that proves the rule. Six months is a short period of time and I have had good experience with dollar cost averaging for other investments over longer time frame – several years up to 10 years.
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