100 + 200 + 133.333 = 433.333 shares
433.333 shares x $7.50/share = $3250
You only put in $3000, the fund never broke even to
$10/share, and yet you still made $250! How did this
happen? This particular technique is called Dollar Cost
Averaging – every time period (every year, every month,
every paycheck, etc.) you put in equal amount of money
(in this case $1000 each time). You’re mathematically
forced to buy fewer shares when prices are expensive,
and you’re mathematically forced to buy more shares
when shares are cheaper. Just by being disciplined and
investing regularly, you mathematically mitigate risk.
In order for Dollar Cost Averaging to work, however, you
must stick to your plan of investing every period. You
cannot say “gee, I think the markets are going to tank, let
me hold off on contributing this time.’
first. Think about it: if the government all of a sudden
imposed a 20% tax on you just for existing, you’d grumble,
but you’d pay and somehow compensate and make it work.
Think of paying yourself as a wealth tax you pay to your
future self, the most important person in your world. You’ll
thank yourself later.
“OK, I’m saving, Now what?”
Consider the following example: there is a hypothetical
mutual fund, let’s call it Fund XYZ. One year it’s $10/share.
The next year, it crashes 50%, to $5/share. The next year, it
goes up a whopping 50%, to $7.50/share. (figure 2)
Figure 2.
Lesson 1 from Figure 2: losses are larger than we think. If
a stock or fund crashes 50%, we have to make 100% just
to break even. Even though one year this fund lost 50%,
and the next year gained 50%, some financial analyst may
say that the average gain was 0%. However, if we take the
annualized average, Fund XYZ actually had an annualized
loss of 13%/year. Be very careful when someone tries to sell
you an investment and states “the average return has been…”
ask questions and clarify, is the average they’re describing
a mathematical average, or an annualized average? Big
difference.
There will always be bad news out there to scare away
investors. If ignorance stops most people from investing,
fear stops those who actually think about investing.
With Dollar Cost Averaging, we mitigate risk. We feel
good when the markets go down, because then we can
say “great, I’ll be buying more shares with this periodic
investment!” And we feel good when markets go up,
because then we can say “great, my investments are
growing!”
David Yeh is an investment adviser representative
with the Wealthy Doctor Institute LLC, a registered
investment adviser.
Information presented is for
educational purposes only and does not intend to make
an offer or solicitation for the sale or purchase of any
specific securities, investments, or investment strategies.
Investments involve risk and unless otherwise stated,
are not guaranteed. Be sure to first consult with a
qualified financial adviser and/or tax professional before
implementing any strategy discussed herein. Past
performance is not indicative of future performance.
Lesson 2 from Figure 2: Let’s say every year you sock away
$1000.
Year 1, you bought $1000/$10/sh = 100 shares
Year 2, you bought $1000/$5/sh = 200 shares
Year 3, you bought $1000/$7.50/sh = 133.333 shares.
So total in: $1000 + $1000 + $1000 = $3000
Total shares you’ve bought:
Figure 2