Dollar cost averaging or bleeding to death

Dollar cost averaging can be a wonderful way to invest. It is a well established long-term investing method. Probably everyone in the mainstream financial media agrees with this. But you need to know why it doesn’t always work. Dollar cost averaging is the method where one puts a fixed amount of money to work at regular intervals, buying at whatever price the market bears. This results in buying a differing numbers of shares each period with the same amount of money. When stocks are high, your money buys less. The lower the price of the stocks, the more shares you’ll get. Over time, the costs for buying the shares at different price levels averages out, typically lowering your overall cost basis. Sounds fine, right? But there is one basic assumption that the success of dollar cost averaging hinges on: you must invest regularly – on a monthly schedule for example – through both up and down markets, in order for it to actually work over the long term. Unfortunately, many people do not stick to their plan in a down market. Instead, they get concerned or depressed about how much money (on paper) they have lost, and so they sell. This results in people selling low after buying high – the exact opposite of what they are suppose to do! Dollar cost averaging can only work if you have the guts to keep investing regardless of the price level. Recent history has proven that this is asking too much of many folks, especially with the 70%, 80%, 90% or more drops in value that some major widely-held companies have had. Some might think that if a person liked a stock at $65, then they would absolutely love it when it was available at $6.50. But in reality it just doesn’t work that way for many people. They panic and sell low instead, completely defeating the intended purpose of dollar cost averaging. They have ended up throwing good money after bad. Let’s assume you have been investing $200 each month for several years, the markets have generally been trending up, and your investment has grown to $10,000. But then the markets go down substantially over the next several months and that $10,000 now is reportedly worth only $5,000 on your statement. Worse, the whole economy looks like it is in the tank and stocks might just keep going lower for a while longer. How would you react if on your next statement your balance went even lower – to $2,500? Would you be happy that your same $200 is buying many more shares than before, or would you be tempted to “cut your losses” and sell? That is what a typical investor will do and it will totally defeat dollarcost averaging The message here is if you don’t think you’ll be able to stick to a regular investment schedule, especially in down markets, dollar cost averaging won’t work as advertised. Before you jump in and agree to start dollar cost averaging, know your self and your proclivities and act accordingly.

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