Question
Dollar-cost-averaging is a great strategy to reduce some of your investing risk. One reason I like it as a planner and an investor is that
Dollar-cost-averaging is a great strategy to reduce some of your investing risk. One reason I like it as a planner and an investor is that it allows me to invest without worrying about if its the right time (at low prices) to invest. Instead, I just invest the same amount out of each paycheck and put my investing on auto-pilot. Lets look at another reason DCA is a good strategy for its impact of the cost of your investments, especially during a crash.
Assume a situation where an investor dollar-cost-averages $6,000 per year into the stock market over 3 years.
In year 1 the investor had to pay $20 per share for his fund.
In year 2 the market crashed (Market Risk) and the investor paid $12 per share.
In year 3 the market recovered somewhat and the investor paid $16 per share.
At the end of year 3, the shares were worth $16 per share.
Complete the following chart (on the next page), after reading through the inputs for Year 1, which are given as an example to help you get started.
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| Year 1 | Year 2 | Year 3 |
A | Dollar amount invested EVERY year. (In DCA, the same AMOUNT is invested on a regular basis) | $6,000
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B | Share price on the date of the investment | $20 |
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C | Total number of SHARES purchased. (This will be different each year, due to the fact that the share prices were different on each purchase date, but the same amount of money was invested). Calculation = Row A Row B (Year 1: $6,000 $20/share) | 300 shares |
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D | Value at end of YEAR 3 (given) | $16 |
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E | Original cost of shares (Row B) | $20 |
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F | Gain or loss PER SHARE at the end of Year 3 (Row D Row E) | Loss of $4 |
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G | Per share Gain or Loss (from Row F) | -$4 |
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H | How many shares does this gain or loss apply to? (from Row C) | 300 shares |
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I | TOTAL GAIN or LOSS for this years shares (Row G x Row H) | -$1,200 (loss) |
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J | TOTAL GAIN ON ALL SHARES (combination of all the individual losses and gains in Row I) |
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Now that youve completed the above chart, explain how dollar-cost-averaging allows the investor to make a profit on stocks during (or from) a crash? Use Exhibit 17 and the above to provide an example in your response.
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