dollar cost

Sometimes when you invest a dollar, you can gain more. Continuing our three-part series on investing strategies, this column focuses on dollar-cost averaging.

Dollar-cost averaging

Investors use dollar-cost averaging when they own a stock/fund and want to buy more. Followers of this strategy invest a fixed dollar amount at regular intervals to buy additional shares. The goal is to buy as many shares as possible with a set sum of money, regardless of the stock’s price on the day of the transaction. This way, when prices are low, more shares are purchased with the fixed amount than when the prices are higher. Since market prices fluctuate, investors using this strategy end up owning more shares purchased at lower prices.

For example, imagine that an investor put in $1000 into purchasing shares every month. In January, he buys shares in ABC that are worth $50 a share. So he uses his $1000 to buy twenty shares. The following month, ABC went down and they are now worth $25 each. Therefore, in February, the investor’s $1000 would be invested in forty shares rather than twenty because the prices are now lower and his money can buy more.

 On the other hand, had the market gone steadily up, he would have been better off buying the shares all at once in January. Following our example, if ABC moved up to $75 per share, he could only buy about 13 shares. He would own fewer shares, though at least he didn’t buy as many at a high price. Since there is no way of knowing how the market will move, dollar-cost averaging spreads the risk by diversifying purchases over time.

One complaint that people have with dollar-cost averaging comes when they sell their position and have to calculate their capital gains in order to know how much tax to pay. Each purchase has its own separate cost basis. So in this example, you would have to figure out the gains you made on each $1000 that you invested. Good software and/or clear brokerage statements can help with this task. One way to avoid the hassle of having to make these calculations is to use this strategy in tax-deferred accounts (such as IRAs), where taxes aren’t paid each time a security is sold at a profit. 

To learn more about the best ways to make money in an IRA, click here.

Douglas Goldstein, CFP®, GFP®, is the director of Profile Investment Services, Ltd. www.profile-financial.com. He is a licensed financial professional both in the U.S. and Israel. Call (02) 624-2788 for a consultation on how to set up your American assets to meet your financial goals. Securities offered through Portfolio Resources Group, Inc. Member FINRA, SIPC, MSRB, FSI. The opinions expressed are those of the author and not those of Portfolio Resources Group, Inc. or its affiliates. Neither PRG nor its affiliates give tax or legal advice.

Published December 11, 2013.

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