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Zhi Finance » How does the “average cost method” improve the return on investment?

How does the “average cost method” improve the return on investment?

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“Dollar Cost Averaging” (DCA) sounds like a mysterious financial term, which requires some business knowledge to understand. Actually not. This passage not only fully explains its concept, but also makes you realize that you may have already done so, and it is likely to help you fulfill your long-term savings plan.

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Average cost method: This term refers to investing the same amount of money in public funds every month (or every week, or every two weeks) to buy stocks, bonds, ETFs, REITs or other financial products.

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In the long run, you can occasionally make small gains by investing the same amount of money every month in stocks, bonds, REITs, ETFs or other financial products with fluctuating prices. You may buy more shares than a one-time bulk purchase, or a purchase that “captures market opportunities” when prices are low.

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In the same period of time, when investing with the same amount of money, the price rises, and the number of shares or assets purchased is less. If the price is lowered, more shares or assets will be bought.

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Take a look at this example:

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Suppose that you will spend $100 on the first day of each month to invest in public funds and buy stocks. At the beginning, the stock price is $20 per share, and you can buy five stocks on the first day of each month. The share price will rise to $25 next month, and you can only buy 4 shares. Next month, when the share price drops to $16.67, you can buy six shares. If you can avoid transaction costs and stick to this principle of investment, over a long period of time, your income will usually increase with the increase of purchase.

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The worst way is to capture the investment opportunities that you think are appropriate to buy financial products, which is contrary to this investment model. Let’s take the above situation as an example. Suppose you have the courage to monitor the stock price for three consecutive months. When the price is $16.67, you can buy it for $300. That sounds wonderful, doesn’t it? But if the share price drops to $10 next month, it will be bad. Driven by price inertia, distressed investors tend to make bigger mistakes, investing at a price of $25 and expecting prices to rise.

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If you invest in a 401 (k) retirement benefit plan, you can already realize the benefits of the average cost method. A small amount of money is deducted from your salary each time as an investment in your 401 (k) retirement benefit plan. The investment follows a strict schedule. No one captures market opportunities, and you can fully appreciate the benefits of the average cost method.

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If you haven’t joined the 401 (k) retirement benefit plan, join it now! If your employer does not provide a 401 (k) retirement benefit plan, you can regularly invest in a public fund every month. The effect is the same. With the increase of assets, you can also open a brokerage account for public fund investment. Most discount brokers can even help you make small investments in certain public funds without charging transaction fees. It is worth noting that all the advantages of the average cost method will be offset if the broker requires a commission or a sales fee when investing in public funds. Don’t do that.

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It’s easy, isn’t it? You may have enjoyed the benefits of the average cost method, and now you have a full understanding of it.