What goes up in the stock market usually comes down. At least on occasion. And often only for a little while. Which means, when you buy in, you may or may not have hit the low, which is the sweet spot of taking a position in a stock.
When you miss that mark, when the stock sinks beneath your original buy-in point, and if you continue to believe in the stock going forward, then dollar cost averaging is a strategy you should consider.
Making Dollar Cost Averaging Work For You
The key to successful dollar cost averaging is an on-going belief in the stock itself.
Because with this strategy you’ll be buying more of it, and you’ll be doing it into a lower market. If the value loss that creates this opportunity sours you on the company, a better strategy is to either sell now and take your lumps or simply hold on for the long run.
But savvy investors know there will always be price swings, and reasonable dips in stock prices come with the territory. So if you still like the stock, you can bring your overall cost-per-share – the average cost of the aggregated amount of stock you hold in a given company – buy purchasing even more of it.
The Numbers Don’t Lie
Let’s run some numbers and see how this works. Let’s say you buy 100 shares of XYZ at $20 per share. Then, two weeks later the price sinks to $16. You still like the stock, so now you’ll buy 100 more shares at the lower price.
You now own 200 shares at a total investment of $3600. That’s a cost-per-share of $18. By this measure half your shares are underwater by $2, and the other half is up $2. In the aggregate, you’re no longer down the $4 per share you were with the first 100 shares, you’re only down $2 per share overall.
Which means, the stock only needs to rebound two points, from $16 to $18, for you to be dead even on your investment. Whereas, had you stuck with the first 100 shares only, the stock would have had to rebound $4 per share to $20 for that to happen.
Of course, like anything in the market, this upside opportunity comes with some measure of risk, because there’s a chance the stock won’t rebound at all, or soon enough. Which means, you’ve just thrown good money after bad.
If you dollar cost average over time, and if your stock do indeed rebound, you can seize the inherent opportunity of natural market swings to lower your coast basis across all your holdings in a given security
