Old Technique Helping During Market Pullbacks: Dollar Cost Averaging
When it comes to investing, a dollar cost averaging technique can result in positive outcomes. This article will walk through two different scenarios demonstrating how this technique can play out. If you have any questions on dollar cost averaging and how you can leverage the technique, please reach out to your M3 Financial representatives.
How does dollar cost averaging work?
Dollar Cost Averaging consists of investing a fixed amount of money, regardless of the market conditions at regular intervals – such as fixed contributions from each paycheck into a 401(k) or 403(b) plan. This can greatly benefit investors, as long as prices eventually go back up.
In January, the investor places $600 into the ABC Stock fund during a market peak of $20 per share. The investor in this scenario obtains 30 shares of ABC stock fund. The investor decides to halt investing any money into ABC stock fund in February and March because the price of the fund fell to $8 in February and then rose back to $16 in March. The 30 shares of ABC stock fund are worth $480 using the March price of $16 per share.
Notice how the investor in this scenario lost $120 or 20% of his portfolio value.
Now let’s take a look at how dollar cost averaging could have been beneficial to this investor.
The Investor puts $600 into ABC stock fund and utilizes the dollar cost averaging method. In January, the stock was $20 per share and the investor puts in $200, resulting in 10 shares. In February, the stock is $8. The investor’s $200 grants them 25 shares. During March, the stock is $16. The investor remains consistent and puts in $200, resulting in 12.5 shares.
In scenario one the investor lost 20% of their account compared to the second investor, who saw a 26.7% gain.
This demonstrates how buying into the market at a peak and staying consistent through the lows can reward the investor as markets come back to a peak.
Dollar cost average can be an effective technique that can help during market pullbacks. The above scenarios show the difference between investing during a market peak, and stopping due to the decrease in the share price vs. consistently investing a fixed amount of money, regardless of the market conditions at regular intervals. Scenario one saw a 20% decrease in their portfolio value while scenario two saw a 26.7% gain.
This is a prime example of the benefits investors can see if they have fixed contributions from each paycheck going toward a 401(k) or 403(b) plan, as long as the prices eventually go back up.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Past performance is not indicative of future results.