Dollar-Cost Averaging and How It Helps Investors

There are 2 types of dollar-cost averaging, reading on can help determine which type of dollar-cost averaging is being used by yourself.

We understand that dollar-cost averaging works as the name says it, averaging out the price with every purchase you make, using a fixed amount of money per day to make purchases. For example, spending S$3 per day for 6 days to buy apples.

Below is an illustration to better help you understand the benefits of Dollar-Cost Averaging:

 

When you average out the price paid per apple, you now pay only S$1.20 per apple, across all the 15 apples you bought, regardless of how much they cost right now. It is a win-win situation, as you now have the apples you wanted, without needing to take note of how much they cost each day, and are still able to buy as many as possible, using the same amount of money each day, but bought at different price levels.

Sounds good, right? Another type of dollar-cost averaging is considered more to be averaging the value more than dollar as you only buy when you think the price is low. Below is an illustration on averaging the value across 6 days, using S$6 every time you make a purchase, with a total budget of S$18, assuming you only wish to purchase the apples when you think the price is the current low:

Using the same S$18, an apple now costs S$1.29 if I were to use the value averaging method, as I only purchase at the price which I think is the lowest low, and did not make a purchase when I think the price is not at a satisfactory low (even when it became even lower than the previous day, I did not make a purchase for fear that the price may go higher.)

Using the illustration above, I did not make a purchase on Days 2, 3, and 6 even when the prices are low, as my own analysis and observation stopped me from making the purchase, as well as the constant market watching did not allow me to immediately buy in at that price level, and the risk of not being able to buy on time is there (i.e. rushing down to the fruit stall to make a purchase after seeing the low price however, the price may suddenly change due to the supply and demand of the apple).

I personally prefer the Dollar-Cost Averaging methodology in the long-run as it helps to average out my monthly costs, based on daily purchases. This way, I also do not have to worry about rising or falling prices, I will have the apples that I want daily, with the price being spread out.

Have you managed to decipher which type of dollar-cost averaging method you have been using based on our above illustration? 😉

Watch this space, as we share more on when should we be using the dollar-cost averaging methodology for investments.

 

 

 

Wendy