REDUCING PRICE FLUCTUATIONS
One
strategy for accumulating shares and reducing the impact of security price
fluctuations is to average the position is more commonly known as "Dollar
Cost Averaging".
PERIODIC PURCHASES
Under
the periodic purchase plan, the investor decides to buy additional shares of a
security at regular intervals. For
example, the investor may elect to buy $2,000 worth of a security every quarter or
every month. This purchase is made
at the appropriate interval, no matter what the price of the stock.
The aim of such purchases is to acquire more shares of the stock when its
price is down and fewer when its price is up.
The effect of a periodic purchase program is illustrated in Exhibit 1,
which shows the number of shares of stock purchased at various prices when
$2,000 is invested each quarter.
EXHIBIT 1
- DOLLAR COST AVERAGING ILLUSTRATION
Price of Number
of
Total
Average
Yr/Qtr
Stock
Shares
Shares
Cost
1 / 1 $25
80 80
$25.00
1 / 2
28
71
151 26.50
1 / 3
33
60
211 28.44
1 / 4
27
74
285 28.07
2 / 1
21
95
380
26.32
2 / 2
18
111
491
24.44
2 / 3
20
100
591 23.69
2 / 4
25
80
671
23.85
The
first column gives the dates of purchase, and the second column presents the
various prices of the security; the third and fourth columns list the number of
shares purchased and the total number of shares held in the position.
The last column presents the average price of the stock held in the
position. The client should notice
that when the price of the stock rises, $2,000 buys fewer shares.
For
example, at $33 per share, $2,000 buys only 60 shares, but at $18 per share, the
investor receives 111 shares. Because
more shares are acquired when the price of the stock falls, this has the effect
of pulling down the average price of a share.
In
this example, after two years, the average cost of the stock had fallen to
$23.85 and the investor had accumulated 671 shares. If the price of the stock rises subsequently, the investor
will earn more profits on the lower priced shares and thus will increase the
return on the entire portion.
The
preceding discussion and example explain the essentials of averaging.
As
a word of caution, Dollar Cost Averaging does not guarantee a profit or protect
against loss in a declining market. Depressed
securities may remain depressed. The
investor, however, should not assume that such a strategy would lead to a
positive return on the investments. Stocks
that have a downward price trend may not change course, or many years may pass
before the price of the security rises to its previous level.
Investors should always consider their ability to continue to purchase shares
through periods of low price levels.
and C