The Benefits of Dollar-Cost Averaging in a Volatile Market

The Benefits of Dollar-Cost Averaging


Volatile Market that ends up flat

Period      Amount       Price        No of shares 
             Invested $      $       Purchased 
1       1,000       100       10.00 
2       1,000         80       12.50 
3       1,000         60       16.67 
4       1,000         80       12.50 
5       1,000       100       10.00 
                  
Total Invested       5,000             
Total shares purchased                   61.67 
Average cost of shares purchased $                   81.08 
Value at period 5 ($)             6,166.67       
                  
                  
                  
Ebullient Market that rises continually                  
                  
Period      Amount       Price        No of shares 
             Invested $      $       Purchased 
1       1,000       100       10.00 
2       1,000       110       9.09 
3       1,000       120       8.33 
4       1,000       130       7.69 
5       1,000       140       7.14 
                  
Total Invested       5,000             
Total shares purchased                   42.26 
Average cost of shares purchased $                   118.32 
Value at period 5 ($)             5,916.32       


The table above shows that you actually end up with more money in the scenario where the market is very volatile and ends up exactly where it began.

In both cases, a total of $5,000 is invested over the 5 periods.  

In the flat volatile market, the investor ends up with $6,167, while in the scenario where market prices rise continually, the investor's final fund stake is only $5,915.



Learning Points:

Warren Buffett, has a nice way of showing that you might actually wish for lower stock prices (at least for awhile) after you begin your investment program.

He writes:

If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?  Likewise, if you are going to buy a care from time to time but are not an auto manufacturer, should you prefer higher or lower car prices?  These questions, of course, answer themselves.

But now for the final exam:  If you expect to be a net saver during the next 5 years, should you hope for a higher or lower stock market during that period?   Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall.  In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying.  This reaction makes no sense.  Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.