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Dollar Cost Averaging In A Down Market

Provided by Rajesh Jyotishi Email Provided by Rajesh Jyotishi
April 2009
Dollar Cost Averaging In A Down Market

(Dollar cost averaging is the practice of investing in a particular investment or portfolio in fixed dollar amounts at regular fixed intervals, regardless of the share’s price. The investor purchases more shares when prices are low and fewer shares when prices are high, thus lowering the average cost per share over time.)

The central idea: buy low, sell high.

It’s the oldest stock market adage, and in the wake of the recent selloff, dollar cost averaging may give you a method to capture lower prices today and come out ahead tomorrow.

How it works.

Dollar cost averaging is a long-term investment strategy. It means investing in smaller and/or regular increments. Through scheduled investments of as little as $50 or $100 per month, you buy investment shares over time, as opposed to pouring a big lump sum into the market. The method is often recommended to younger investors with longer time horizons, and investors who don’t yet have great wealth.

Why it is worthwhile in a bear market.

First of all, when the market drops, the investor practicing dollar cost averaging generally isn’t hurt as much as the lump sum investor, as the lump sum investor can hold many more shares of the declining investment or stock.

Second, a stock market downturn produces a kind of “clearance sale” environment. Picture Wall Street as a department store, with signs everywhere announcing 20% or 30% off. You have a chance to buy into some top-quality companies “on sale.” As a consequence of dollar cost averaging, you can now buy in at a lower price, and buy more shares for your money. It is interesting that when Macy's has a one day sale, people can't wait to go in and buy things, but when the stock market is 50% off, people can't wait to get out. This reflects their comfort with risk. Since there are no guarantees that things won't get worse, if you are totally not comfortable with the market, you could consider staying out for some time. The worst thing that can happen is that you may miss out on some of the gains if the markets were to bounce back. However, if at this point you change from being a lump-sum investor to a dollar cost averaging investor, you can stay involved with less risk and be pleased later.

So what happens when the market recovers? As the market rebounds, you can pat yourself on the back. You were able to buy more at the bottom of the market, and as the market rises, you will have a lower cost basis and you can enjoy the associated gains. All the while, you continue contributing to a winning investment or stock.

Perhaps most importantly, you stay invested. Dollar cost averaging gives you a regular, passive investment strategy as opposed to market timing. In a volatile market, the active investor can quickly become a frustrated casualty of his or her impulses—and foolishly “abandon ship.”

You might call this a tortoise-and-hare analogy. The active investor sprinting all over the place for spectacular gains is the hare; you, through dollar cost averaging, emulate the tortoise. It may not be the ‘sexiest’ way to invest, but in a down market, it is a long-term approach well worth considering.

Learn more. We have witnessed a huge downturn in stocks. The question is, how are you positioning yourself to take advantage of the markets when things rebound? This is a good time to meet with a financial advisor to review or rebalance your portfolio, and to look past the headlines of the moment and toward your long-term objectives. If you’re not currently practicing dollar cost averaging, you may want to talk about the concept with your advisor.

Note: Dollar cost averaging will not guarantee a profit or protect against a loss in a declining market. Investors should consider their ability to continue to invest on a regular basis during all types of economic times.

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