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Dollar Cost Averaging The Magic of Dollar Cost Averaging
It’s always been the same; it never changes. We can remember back
in the 1970’s talking to brokers who would buy a stock for a
client, and the stock would fall out of bed. If it still made sense to
own the stock, the broker would tell the client to average down. So let’s
take a hypothetical example. Your broker buys you a thousand shares of
AT & T at $ 50 per share. The stock then goes to $ 20 per share. He
tells you to buy another thousand shares at $ 20. Your average cost
basis is now $ 35 per share. $ 35 is still one hell of a ways from the
current price of $20. It looks like this:
- Simple Averaging
Total Cost $ 70,000
Average Cost ($70,000/2000
shares) $ 35 per share
After 30 years we can tell you that this is not the way to average
your cost. The mistake that brokers make is that they have you buy the
same number of shares at each price level. The magic of dollar cost
averaging is that you put in the same number of dollars as your original
investment at lower price levels. In the example above instead of buying
a thousand shares at $20 per share, you would be buying $ 50,000 worth
of ATT at $ 20 per share. $50,000 worth of ATT at $ 20 per share is
equal to 2500 shares. Let’s take the example above.
- Dollar Cost Averaging
Total Cost $ 100,000
Average Cost ($100,000/3500
shares) $ 28 per share
Instead of generating a cost basis of $ 35 per share, you now have
a cost basis of $ 28 per share. This is a very important concept we are
pointing out to you. If you want to see this concept work big time, then
let’s look at Lucent Technologies. The stock is down from $ 84 per
share. Let’s say you bought 1000 shares at $ 80 per share. Your
cost for the 1000 shares would be $80,000 The stock then went to $ 5 per
share. Using dollar cost averaging, you would buy $ 80,000 worth of
Lucent at $ 5 per share. That’s 16,000 shares folks. Look at the
example below to see your new average cost.
- Using Simple Averaging
Total Cost $ 85,000
Average Cost ($85,000/2000
shares) $ 42.50 per share
- Using Dollar Cost Averaging
Total Cost $ 160,000
Average Cost ($160,000/17,000
shares) $ 9 per share
As you can see, if you used simple averaging which is what 99
percent of the brokers in America recommend, then your average cost is $
42.50 per share. On the other hand if you employ Dollar Cost Averaging,
you bring your Average cost down to $ 9 per share which is very close to
the actual low of $ 5 per share.
There are a couple of things you have to think about before you
utilize this concept in your investment thinking. They are:
- You better be sure that this stock is coming back, or you will
get your clock cleaned
You have to be absolutely comfortable with your knowledge base
concerning the stock in question, or you will be scared out at the
bottom. This means you will be selling, instead of buying the
stock
You have to have the cash to play in this arena. This is why
you never ever go on MARGIN. Margin kills
As part of point 3) above, always keep some dollars in reserve.
Here’s to your success, now and in the future. And remember to
use Dollar Cost Averaging.
Regards,
Your Friends At
StocksAtBottom.com
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