Discipline, not analysis, should be the most critical element for successful investment. Dollar cost averaging is a powerful tool in disciplinary investing. The principle of dollar cost averaging is simple: invest a fixed amount of money in funds, for example, at regular intervals, regardless of whether the market is up or down. The beauty of dollar cost averaging is that investors can buy more units when prices are lower and fewer units when prices are higher, which increases the portion of accumulated fund units with lower unit cost. Dollar cost averaging possesses an automatic-adjusting system that avoids investors to buy units at high price and capture the opportunities to buy more units at lower price. This system also takes the decision-making, which can be influenced by emotion and temptation, out of your hands, which evades a general emotional barrier of neither buy at high price nor low price in the investment process. Meanwhile, the system gets investors a better price than if they made guesses about when to buy and how much they should buy, and eliminates the risk involves in market timing.
Example: Invest $1,000 per month for six months. Higher profits will be generated in an investment with a fluctuating price.
The stock market goes up and down. And greater fluctuation greatly benefits the dollar cost averaging system. Using the table above, when prices drop to $6 from $10 and then rebound to $10.50, the lump-sum investment return will be:
(10.5 – 10) / 10 = 5%
Through dollar cost averaging, the return will be much more fruitful in a fluctuating market:
(7,748 – 6,000) / 6,000 = 29%
Of course, this simplified example cannot illustrate the power of dollar cost averaging when the market is volatile and then goes up. To fully utilise the system, a three- to five-year time horizon is recommended, rather than just six months. People will ask how, if the market continues to up? No doubt, lump-sum investing should be much better. However, when taking the passage of time into account, returns from dollar cost averaging are not so inferior.
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