Have you ever purchased anything and then it suddenly drops in price the following week (no offense iPad users). This is, in fact, so dissatisfying to most customers that stores have created specific policies around price matching.
These days if your product is on sale after the original purchase you can usually get the difference between the higher and lower price within 30 days or so from the original purchase. Unfortunately, with stocks you don’t have the same option. Or do you?
What is Dollar Cost Averaging?
Every block of stocks you purchase comes carries a certain “cost basis”. This is a fancy word for “how much did you pay?” Let’s assume you purchased 10 shares of company ABC for $10 each. The total cost would be $100 (trading fees excluded). Your cost basis is $10 per share ($100 total cost / 10 shares). This is of course an overly simplistic example as in most cases the cost basis would also include reinvested dividends etc.
If stock for the company ABC dropped to $8 per share and you purchased 10 more shares, you would now have a total cost of $180. Your cost basis would now have dropped down to $9 per share ($180 total cost / 20 shares).
It’s that simple. The real power of DCA (dollar cost average) is that you can recoup your losses faster and achieve greater earnings once the stock has recovered.
Thousandaire portfolio performance update – March:
The reason for telling you about DCA has a purpose. In fact, several stocks in the Thousandaire portfolio have not performed as well as we would have liked. Here is our overall performance YTD:
Total Investment: $2,774.00
Thousandaire Portfolio Value: $2,757.80 (-0.58%)
S&P 500 Value: $2,800.60 (+0.96%)
Worst performers:
The two worst performers in the Thousandaire portfolio are F and LVS at ~10% loss each. This is not completely unexpected, since both of these stocks are incredibly volatile. For a volatile stock a 10% gain/loss should never be unexpected.
After some quick research it looks like the fundamentals for either stock have not changed significantly, therefore this is a great opportunity for DCA. It’s almost as good as returning something to the store for a price match.
This week’s Thousandaire stock picks are:
$125 in F
$125 in LVS
Word of Warning:
Before purchasing any shares to DCA, make sure you still believe in the company and their future. Purchasing more stock will increase your exposure to a specific company or sector which will increase the overall risk of your portfolio.
Disclosure:
I don’t have a position in LVS and do not plan on purchasing any in the next 60 days. I have a long position in F.
Kevin’s Take:
While I never like to see stocks go down, I’m really glad we had to opportunity to address dollar cost averaging. I have used this many times in the past, and it has helped me recover losses much more quickly. It seems counter-intuitive to think “These two stocks have sucked, so I should buy more of them???”, but this is truly the best way to make money in the long run. You want to buy low and sell high. If you liked the stock at the original price, you’ll probably like it at the cheaper price too!
Important to note that ALL ideas, thoughts, and/or forecasts expressed or implied herein are for informational and entertainment purposes only and should NOT be construed as a recommendation to invest, trade, or speculate in the markets.
Dollar cost averaging really is a valuable idea. And it is one (of several) thing that make 401(k)s a great way to invest. You get regular purchases of investments and take advantage of the benefits of Dollar cost averaging. Plus you often get matching (huge benefit) and tax deferral (huge benefit).
Yeah, people DCA in their 401ks and don’t even know it is happening. However, they are technically dollar cost averaging investments that went both up and down. I like to focus my DCA just on stocks that I can get cheaper.
I love dollar cost averaging. I do it automatically through my bank by putting a set amount in my investments twice a month. Easy and good for my portfolio. Win!
DCA works best when stuff stuff you bought costs less than where you bought at first. If it costs more, you are still doing a DCA, but you are actually raising your average cost basis.
Dollar cost averaging is a great tool for the average investor. It’s too bad many investors stop investing when the market is down, they need to read Thousandaire.
Yep, one of my worst 2010 decisions was to stop investing in AMT because it was the only one of my stocks that was down after the first few months of the year. By the end of the year, it had a very nice gain of about 15%, and because I was scared at the low price, I had much less exposure to AMT than my other, less profitable investments.
Dollar cost averaging is really a great tool to smooth out the fluctuation in the stock market. That’s why retirement plans such as the 401k and IRA worked out better for most people when they utilize the DCA method. Most people do not have the time and expertise to wait out what’s going to happen to the stock market before they invest. Investing consistently on a monthly basis beats out the highs and lows in the market.