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RICHWealth Resources
Dollar Cost Averaging
From Wikipedia, the free encyclopedia
Dollar cost averaging (DCA) is an investment strategy, that may be used with any currency. It takes the form of investing equal monetary amounts regularly and periodically over specific time periods (such as RM200.00 monthly) in a particular investment or portfolio. By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high. The point of this is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time.
Dollar cost averaging is also called the constant dollar plan (in the US), pound-cost averaging (in the UK), and, irrespective of currency, as unit cost averaging or the cost average effect.
In dollar cost averaging, the investor decides on three parameters: the fixed amount of money invested each time, the investment frequency, and the time horizon over which all of the investments are made. With a shorter time horizon, the strategy behaves more like lump sum investing. One study has found that the best time horizons when investing in the stock market in terms of balancing return and risk have been 6 or 12 months.
One key component to maximizing profits is to include the strategy of buying during a downtrending market, using a scaled formula to buy more as the price falls. Then, as the trend shifts to a higher priced market, use a scaled plan to sell. Using this strategy, one can profit from the relationship between the value of a currency and a commodity or stock.
Assuming that the same amount of money is invested each time, the return from dollar cost averaging on the total money invested is : -
where Pf is the final price of the investment and Pp is the harmonic mean of the purchase prices. If the time between purchases is small compared to the investment period, then can be estimated by the harmonic mean of all the prices within the purchase period.
