Dollar Cost Averaging is a strategy of investing a fixed sum of money on a regular basis into a fluctuating market price. Over time an investor should be able to achieve an average cost per share which is below their average price per share. Dollar cost averaging is a popular investment strategy with mutual fund investors.
Applying "Dollar Cost Averaging" to Securities Exams:
Two things must occur for dollar cost averaging to work: the market value must fluctuate and the customer must be disciplined in making fixed investments at fixed intervals. Ex: month 1 $100 invested $20 share price buys 5 shares month 2 $100 invested $12.50 share price buys 8 shares month 3 $100 invested $10 share price buys 10 shares month 4 $100 invested $25 share price buys 4 shares
The customer’s Average Cost is $14.81 ($400 total invested divided by 27 total shares purchased)
The customer’s Average Price is $16.88 ($67.50 total share price divided by 4 investments made)
Due the regularity of the investments made and the fluctuation in market value, the customers cost is significantly lower than the average price of the shares, resulting in a profit if the customer decides to liquidate today.