Dollar-cost averaging can mitigate market's fluctuations

This article was provided by Timothy M. Reese, senior vice president investments with A.G. Edwards & Sons Inc.

Although we all know markets are cyclical and will fluctuate, swings in the markets can unnerve many investors, making them lose site of their long-term financial objectives. Even worse, these fluctuations can make many investors react emotionally, causing them to buy or sell securities based on fear.

Dollar-cost averaging is a technique investors can use to insulate themselves from these inevitable market ups and downs.

To dollar-cost average, all an investor needs to do is invest a set dollar amount regularly into a given security, regardless of the market price. For example, choose to invest $100 a month in XYZ Company. This means that every month, regardless of the price of XYZ stock, the investor will purchase $100 worth.

Using the same example, let's say an investor puts $100 in XYZ Company every month for six months. Let's say XYZ in January is $2.50, so the $100 would acquire 40 shares. In February that same stock increases to $5, so the money would acquire 20 shares that month. In March and April, the stock is $4, so the investment would purchase 25 shares at the end of each of those months. In May, the investor acquires 10 shares at $10, while in June the stock closes at $20, enabling the investor to buy five shares.

Although the average price of the shares over those six months was $7.58 ([$2.50 + $5.00 + $4 00 + $4.00 + $10.00 + $20.00] divided by 6), the investor accumulated 125 shares of XYZ, paying an average of $4.80 per share ($600 divided by 125 = $4.80).

Because the investor bought fewer shares when the price of XYZ was high and more shares when the price was low, the average cost per share is lower than the average price per share. Remember, this illustration is hypothetical and not representative of any specific investment.

Depending on the type of investment, an investor might be able to begin a dollar-cost averaging program with as little as $50. An investor can choose to invest on a monthly, bi-monthly or quarterly basis. Because the investor buys a predetermined dollar amount of securities at regular intervals, he will know exactly how much he will spend and when, making investing a dollar amount easy to work into a budget.

Dollar-cost averaging is a long-term investment strategy and takes patience and persistence to work, and investors should consider emotional and financial ability to continue through periods of both rises and declines in the markets.

However, it is an approach that takes the guesswork out of investment timing and helps accumulate assets. Because an investor buys more shares when the market declines, he can be in a better position for potential gain when the market rebounds.

This approach to investing ignores daily market fluctuations that can make it harder for investors to reach their long-term financial goals. While dollar-cost averaging doesn't guarantee a profit or protect against loss, it is a widely accepted method of making investment purchases to achieve a lower cost per share and help protect an investor from investing all of his money at the wrong time.

Talk with a financial consultant about whether dollar-cost averaging might be a good investment strategy to help achieve financial goals. Because dollar-cost averaging involves continuous investment in securities regardless of fluctuating prices, investors should consider their financial and emotional ability to continue the program through periods of both rising and declining markets.