at their 52-week high, but you may also buy shares at their all-time low. Over time, the cost of the shares averages out, so that you are neither paying top dollar, nor are you paying bargain basement prices. But employing the DCA method doesn’t guarantee a profit, nor will it insure you against a loss.
Dollar-cost averaging is generally used for mutual funds, but may also be used within the subaccounts of annuities, which we discussed in Chapter 6. Let’s assume that you want to invest a total of $50,000 in the XYZ Growth Fund, but you don’t want to do it all at one time. Rather, you wish to spread out your investment because you don’t know what the market is going to do. Therefore, you decide you want to invest $5000 per month for the next 10 months to make up your entire investment. By doing this, you will be purchasing shares at, presumably, 10 different prices, which could lower your average price per share, and thus, increase your potential for making a profit from this fund. (See Figure 8.1.)
Looking at Figure 8.1, which demonstrates a hypothetical situa- tion, as the price per share fluctuates over time, the investor is able to purchase shares at a variety of different prices, which then equal his average price per share. Notice that the hypothetical purchase prices run the gamut over the time frame. This strategy helps decrease the volatility of investing in a single security by investing over time, instead of in a lump sum. Figure 8.2 provides some more examples on dollar-cost averaging.
For investors who wish to invest in a lump sum, they need to be aware that they may wind up putting their money in at the height of the market, or they may be lucky enough to get in when the market is at a bottom point. This is not to say that one way is better than the other. That choice is up to individual investors and their levels of risk tolerance. If you, the investor, believe that the market will be going back up at the time you are ready to invest, then a lump sum invest- ment may be best. However, if you are unsure about which way the market will go, then perhaps using DCA is the best idea. Essentially, DCA is best for investors who have the cash flow to invest a set amount at regular intervals and aren’t prone to try and decide whether the market is going to go up or go down. This strategy also works the best for those who like to invest and hold a position for a