It’s very difficult to know when to buy an investment. No investor really wants to buy an investment when it’s at its highest price. So how can you help to protect against that from happening?
It’s called “dollar cost averaging.” This is a process where instead of contributing sporadically to an investment you view positively, while trying to time the market, the investor contributes regularly (weekly, bi-weekly or monthly) to this investment, essentially averaging the costs over time.
Let’s look at an example. Say there was a stock whose value changed randomly over time:
Cost of investment
Say you want to buy 120 shares of this stock. You decide to buy it in two installments – one in January, one in July. Given the fluctuating price of the stock, you end up spending $1,680:
| Month | Shares Bought | Price Per Share | Total Cost |
|---|---|---|---|
| January | 60 | $12 | $720 |
| July | 60 | $16 | $960 |
| Overall | 120 | $14 | $1,680 |
However, if you were to buy the same number of shares using dollar cost averaging – you invest the same dollar amount on a monthly basis in the security, – in this example you would get more shares for the same investment.
| Month | Shares Bought | Price Per Share | Total Cost |
|---|---|---|---|
| January | 20 | $12 | $240 |
| February | 17 | $14 | $240 |
| March | 24 | $10 | $240 |
| April | 30 | $8 | $240 |
| May | 20 | $12 | $240 |
| June | 24 | $10 | $240 |
| July | 15 | $16 | $240 |
| Overall | 150 | $11.19 | $1,680 |
Dollar cost averaging is a way of lowering risk by changing how you invest, not what you invest in. By spreading out your purchases evenly over time, you may reduce your chances of buying when the price is too high. In other words, when prices are high, you are buying fewer shares. It takes the guesswork out of the equation.
One way to take advantage of dollar cost averaging is by making sure you ‘pay yourself first’ – that is, having the contribution pre-authorized to be automatically withdrawn from your bank account on a regular basis. Then you’re not only taking advantage of dollar cost averaging – you’re also ensuring that your money goes to your investment goals rather than being spent on items that might be less important in the long run.
At Scotia iTRADE®, there are several ways to do this:
Set up a PAC, or Pre-Authorized Contribution plan.
Arranging a DRIP, or Dividend Reinvestment Plan to reinvest and dollar-cost average your dividends. Scotia iTRADE DRIPs charge no commissions, so your earnings are your own.
To set up a Pre-Authorized Contribution/Deposit download and fill out the form or to set-up a DRIP on your account see your Account Details page.
Don’t have a Scotia iTRADE account? Sign up today.
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