Dollar Cost Averaging In Stocks [8 Top Investing Strategies]

Dollar Cost Averaging In Stocks is a Great Way for Long-term Investors to Maximize Profits & Lower Risk. Analysis of Bull, Bear & Sideways Markets. Learn the advantages and disadvantages.

1. Dollar Cost Averaging Definition

Dollar Cost Averaging is a method of investing whereby an investor scales into a long-term investment with a fixed amount on regular basis (e.g. monthly). When the price of the investment goes down they receive more shares for their money and when it increases they get less.  This averages down the cost per share promoting a successful outcome.

2. What is Dollar Cost Averaging? More Shares Lower Prices Over a Longer Period of TimeDollar Cost Averaging - Time Equals Money

In stock market terms, stock prices go up and they go down.  Dollar Cost Averaging takes advantage of the down period to buy more stock and as the stock price rises less stock is purchased for the same amount.

But here is the clever thing.

If you apply the concept of Dollar Cost Averaging to your investments you can reduce your overall average cost per share

3. Dollar Cost Averaging – Example Fluctuating Stock Price

In this example, the stock price fluctuates around the $10 mark.  Spending an equal time above the $10 price as below it.

1 Payment $8,000 8 Payments $1,000
Quarter Purchased Share Price Number of Shares Number of Shares
Q1 $10 800 100
Q2  $9 111.11
Q3 $8 125
Q4 $7 142.86
Q5 $10 100
Q6 $11 90.91
Q7 $12 83.33
Q8 $13 76.92
Total Shares Owned    800 830.13
Share Value Q8    $10,400 $10,791
Total Profit % +30% +35%
Average Cost Per Share   $10 $9.64

Table 1: Dollar Cost Averaging Example – Balanced Market

In the example above, the investor (let’s call him Larry Longterm) has $8,000 to invest in shares.

Non-Dollar Cost Averaging

The first example is a single payment of $8,000, which buys 800 shares at $10 per share.  At the end of 8 quarters the total share value is $10,400 – (Share Price in Quarter 8 * 800 shares)

Dollar Cost Averaging

In this example, the investor spreads the payment of $1,000 in 8 installments over 8 quarters.  As you can see when the share price is lower, the investor gets more shares for each $1,000 invested.

When the share price is at $7 the investor gets 142 shares for $1,000.  Also, when the share price is higher at $13 the investor gets only 76.92 shares.

Assuming the share price distribution is equal across the 8 quarters (in this example it is), then the dollar cost average investor has, in the end, received a benefit of $391 dollars (the difference between the share value of $10,400 in example 1 and $10,791 in example 2).

This means the dollar cost averaging investor has a profit of 35% and the non-dollar average investor has a profit of 35%.  Not only that the average share price cost is $9.64 rather than $10 per share.

So, all things being equal, especially the share price, Larry comes out on top with an improved profit of 3.8%.

4. Dollar Cost Averaging Strategy – Declining Stock Price

In this example, the stock price reduces from quarter 1 at $10 to quarter 8 at $8 with the lowest price of $6.

1 Payment $8,000 8 Payments $1,000
Quarter Purchased Share Price Number of Shares Number of Shares
Q1 $10 800 100
Q2  $9 111.11
Q3 $8 125
Q4 $7 142.86
Q5 $6 166.67
Q6 $6 166.67
Q7 $7 142.86
Q8 $8 125
Total Shares Owned    800 1080.16
Share Value Q8    $6,400 $8,641.27
Total Profit % -20% +8%
Average Price Per Share   $10 $7.41

Table 2: Dollar Cost Averaging Example

In the example above, the investor, “Barbera Bear” has $8,000 to invest in shares.

Non-Dollar Cost Averaging in a Bear Marketdollar cost averaging in a bear market

The first example is a single lump sum payment of $8,000, which buys 800 shares at $10 per share all at once in one payment.  At the end of 8 quarters the total share value is $6,400 – (Share Price in Quarter 8 $8 * 800 shares) – a loss of $1,600 or a brutal -20%

Dollar Cost Averaging In A Declining Market

In this example, the Barbera spreads the payment of $1,000 in 8 installments over 8 quarters.  As you can see when the share price is lower, the investor gets more shares for each $1,000 invested.

When the share price is at $6 Barbera gets 166 shares for $1,000.

In this case, the share price distribution is declining across the 8 quarters with a little increase at the end. Barbera has, in the end, received a benefit of $641.27 the difference between the share value of $8,641.27 in and $8,000.

This means the dollar cost averaging investor, has a benefit of 35% over the non-dollar average investor  Not only that the average share price cost is $7.41 rather than $10 per share and less than the current market price.

Despite an overall stock price decline of 20% ($10 to $8), Barby has still managed to eek out a profit of 8%

This is the true power of Dollar Cost Averaging.

So, even in a decreasing market, fluctuating within 20% she makes a profit & she reduces her risk.

5. Dollar Cost Averaging Strategy – Growing Bull Market  Stock Price

In this example, the stock price increases from quarter 1 at $10 to quarter 8 at $12 with the highest price of $13. Ultimately a 20% stock price increase

1 Payment $8,000 8 Payments $1,000
Quarter Purchased Share Price Number of Shares Number of Shares
Q1 $10 800 100
Q2  $11 90.91
Q3 $11 90.91
Q4 $12 83.33
Q5 $13 76.92
Q6 $12 83.33
Q7 $13 76.92
Q8 $12 83.33
Total Shares Owned    800 685.66
Share Value Q8    $9,600 $8,227.97
Profit 20% 2.8%
Average Price Per Share   $10 $11.67

Table 2: Dollar Cost Averaging Example Bull Market

In the example above, the investor, Bobby Bull has $8,000 to invest in shares.

Non-Dollar Cost Averaging In A Bull Market

The first example is a single payment of $8,000, which buys 800 shares at $10 per share.  At the end of 8 quarters the total share value is $9,600 – (Share Price in Quarter 8 $12 * 800 shares) – a profit of $1,600 or a 20% gain.

Dollar Cost Averaging In A Bull Market

In this example, the Bobby spreads the payment of $1,000 in 8 installments over 8 quarters.  As you can see when the share price is higher, the investor gets fewer shares for each $1,000 invested.

When the share price is at $13 Bobby gets only 76.92 shares for $1,000.

In this case, the share price distribution is increasing across the 8 quarters with a little decrease at the end. Bobby has, in the end, received a benefit of $227.97 the difference between the share value of $8,000 in and $8,227.97.

This means the poor Bobby has only realized a profit of 2.85% whereas the non-dollar average investor made 20%.

So, even in an increasing bull market, moving up 20% Bobby makes a profit in both examples but his profit is greater as a non-cost averaging investor.

6. Dollar Cost Averaging vs Lump Sum

So we have seen in these 3 detailed examples, that there are certain advantages and disadvantages of dollar cost averaging.

If you are lucky enough to time the market to perfection and buy in at a low price with a lump sum and the market solidly increases over time, you will reap the maximum reward.

However, history tells us that we only have a 5% chance of this happening to us.

The reality is that the stock market fluctuates and sometimes a lot.  Even in an increasing bull market, you can make outsized returns due to the decreases in the stock price during a bull market.

7. Does Dollar Cost Averaging Work?

This is the big question and it can only be answered with our observations in these examples.

  • During Declining Bear Markets – Dollar Cost Averaging will ensure you are more profitable than someone making a single purchase at the top of the market.
  • During Sideways Markets – you will make an abnormally high return due to you purchasing a stock at the low points in price
  • During Raging Bull Markets – you may not make the same profit as someone that purchased at a much lower price, but statistically, they are very lucky or extremely smart to time the market.  But think about this.  Even in a Bull Market, stocks move down in price for many weeks or months at a time, and if you are buying during these periods your average cost per share will decrease and your profit percentage will increase.

8. Dollar Cost Averaging & Dividends

We really should not forget the golden arrow for the long-term investor which is dividends.

If you are investing for 10 to 30 years it is a great idea to invest in companies that have a great business model, a solid market with high barriers to entry and those that pay dividends.

Almost half of the company’s on the U.S., Canadian, U.K. and Australian exchanges pay dividends, some of them up to and above 10% per annum.  Not only that many offer Dividend Reinvestment Plans (DRIPS) and preferential prices for share purchase.  In the U.S. also you can qualify for reduced or even Zero Tax on your dividend gains.

If you add the dividend income to the examples above we can safely say that dollar cost averaging over the long-term can pay off and provide a steady increase in your assets that will contribute handsomely to your investment retirement account.

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