This weeks issue will be discussing the issue of proper timing of placing cash into the market and the amount to do so. More specifically we are going to break down the theory of dollar cost averaging and how this benefits the value investor in receiving the highest return for the lowest amount of risk when placing cash into the market.
Dollar cost averaging in a nutshell is the process of taking a fixed dollar amount you wish to invest and spread it over a given time in order to reduce the overall cost of shares. For an example say you have $20,000 to invest in the market and wish to buy a particular stock (for ease of explanation we will use only one security, but of course always diversify) you need to spread this cash over a period of time. So, you divide the $20,000 into 12 pieces for each month of the year which equates to roughly $1,700 a month. Then very machine like, buy shares on the same day within each month accumulating more shares as the months go by.
This might sound bizarre because why not just wait for a good price and buy all $20,000 worth of stock? The answer is because what you might think is a good share price may not be six months down the road. This is especially true during extremely volatile times in the market, as the overall average (thus the term dollar cost averaging) will be a more attractive share price. You will pay more some months than others, but in the end this is a true way to acquire the shares you desire for the best overall price.
This same technique can be used for multiple stocks by taking the same dollar amount and spreading the monthly buying over multiple stocks. Feel free to be creative with this technique, adjust it to your taste, but stay with the principle and you should be satisfied with the results. This tool is just another for the value investor to utilize as we all seek to minimize cost and maximize return.