Buying Stocks
Buying stocks using cost averaging really work ?
Does buying stock using cost averaging really work? Or does it only work for certain stocks like stocks in the Dow Jones and S&P 500 ?
But the stocks that still in the original Dow Jones is General Electric.
Is cost averaging a myth or does it really work ?
Thanks
This is an interesting question and the answer is not obvious.
Let us consider the main advantage of dollar cost averaging. The advantage is that one is purchasing stocks on a regular basis. It works best with a mutual fund, where one can purchase fractional shares and even have the mutual fund automatically withdraw money from ones bank account regularly. Sometimes it works better than other times.
Here is a link to a site where you can experiment using dollar cost averaging vs lump sum investment in the S&P 500 index fund. You can see what the results are for different time periods.
http://www.moneychimp.com/features/dollar_cost.htm
Now one must keep a couple of things in mind. First, in general stock prices on average tend to rise over time. Certainly not every stock but the average stock. This is due to economic growth in the economies of the world. Consequently, in general a lump sum investment in a particular point in time should outperform dollar cost averaging over time because of the growth trend. But there is one catch to this phenomenon. That is that stock prices and economic growth do not follow a consistant pattern. They tend to oscillate around the norm, sometimes with great extemes as during 1999-2000 on the up side and as 1974-1975 on the down side. Making a lump sum investment during the 1999-2000 period would have resulted in extreme displeasure. Making a lump sum investment during the 1975 bear market would have resulted in extreme elation. But unfortunately not many investors are able to make such a determination at the time. In fact they tend to make counter productive decisions instead. That is to buy at market tops and sell at market bottoms. Dollar cost averaging essentually removes the decision making process from the investment equation and for a large number of investors that is an advantage, often a big advantage.
Stock Market Investing Tips : About Buying Stocks