Dollar cost averaging
INVESTMENT "MAGIC" DOLLAR AVERAGING
In a story in early 1959 on a decision by the State of New Mexico to invest 25 percent of its $159 million Permanent Fund in common stocks (as against a previous practice of holding the entire fund in high grade bonds), it was reported that the $59 million bundle would be sunk into equities under a "slow, four-and-a-half year program," calling for stock purchases of about $1.1 million a month.1
This application of what has come to be known as dollar averaging (or dollar cost averaging) is striking evidence of the high prestige of this investment formula. Although dollar aver-aging is usually thought of in connection with the small investor, a large number of institutions have long been practitioners— especially those such as pension funds, which deal with a constant flow of incoming cash.
The New Mexico example is significant in that it involves a sum of money already on hand. A look at the special circum-stances shows why the New Mexico Investment Council, responsir ble for investing the money, picked the dollar averaging ap-proach. A majority of the eight council members were described as "amateurs" in investing and were undoubtedly reluctant to take the blame for making a quick, big plunge in the market at what might turn out to be the wrong moment—especially in view of the all-time high level of stock prices at the time. As it hap-pened, the market did rise considerably for some time after the initial decision was made. It is therefore easy to say that the plan was wrong, since some stocks could have been bought at lower prices if a sizable portion of the money had been invested right
24
INVESTMENT MAGIC . DOLLAR AVERAGING
at the start. However, it must not be forgotten that quite a large amount of money was involved, and even an investment pro-fessional would not be eager to take the responsibility for de-ciding that any particular moment might be the appropriate time to invest $159 million. Then too, the council members were in positions of public responsibility, and were thus doubly on the spot.
PRINCIPLE OF DOLLAR AVERAGING
The idea of dollar averaging is to purchase the same dollar amount of a stock or stocks at regular intervals—monthly, quar-terly or annually. Naturally, the method is especially appealing to small investors, who perhaps would not be able to buy stocks any other way, and it has been publicized primarily by the New York Stock Exchange in connection with its Monthly In-vestment Plan, and by mutual fund marketing organizations.
Buying stock at regular intervals seems a completely prac-tical and relatively painless way of accumulating a sizable account. More important, however, the automatic result of buying a fixed dollar amount of stocks at each purchase point—instead of, say, a fixed number of shares—is that more shares are bought at low points, and fewer at high points. By increasing the number of shares purchased when prices are low, and cutting down as prices rise, the investor is constantly working to reduce his average cost, so that the average cost of shares purchased is always lower than the average of the prices paid.
For a clearer picture of exactly what this means, take a look at Table 1, showing results of a hypothetical dollar averaging program using the stock of Bond Stores. Over the 15-year period beginning in 1944, the stock rose sharply from the twenties to a high of nearly 50 in 1946, dropped slowly in succeeding years, and recovered near the end of the period. Our dollar averaging program assumes purchases of $1,000 worth of stock on the last trading day of each year, at an approximate average of the high and low prices of that day, the last purchase being made in 1958. The first purchase is at 221/4, and the last at 211/8, with purchases in intervening years ranging from a high of 391/2 to a low of 131/8. Thus we see the operation of the plan over a complete market cycle, in which stock is bought above as well as below
25
HOW TO PROFIT FROM FORMULA PLANS IN THE STOCK MARKET
the initial price, and the last purchase is near the same price as the first. Neither commissions nor dividends are included in the calculations, and investment of the $1,000 in full and fractional shares is assumed.
TABLE 1
BOND STORES
Dollar Averaging Program, 1944-58
Last Updated on 11/5/2005
By geoff
♦Adjusted for 2-for-l split in 1945.
The number of shares purchased ranges from 31.74 in 1946, to 76.19 in 1953. Over the 15-year period, a total of $15,000 is invested, and total market value is $17,878.93 at the end of the plan. While this may seem an unexciting result, it should be noted that the stock itself has not only made no progress at all, but has lost ground.
The reason for the satisfactory result despite relatively poor market performance is, as stated above, that at any time after the beginning of the plan, the average cost of shares purchased is lower than the average of prices paid, because fewer shares are bought at high prices, more at low prices. The discrepancy between the average of prices paid and average cost per share is shown in the table. Not shown in the table are dividends, which would have been considerable, amounting to about $1,000 during
26
In a story in early 1959 on a decision by the State of New Mexico to invest 25 percent of its $159 million Permanent Fund in common stocks (as against a previous practice of holding the entire fund in high grade bonds), it was reported that the $59 million bundle would be sunk into equities under a "slow, four-and-a-half year program," calling for stock purchases of about $1.1 million a month.1
This application of what has come to be known as dollar averaging (or dollar cost averaging) is striking evidence of the high prestige of this investment formula. Although dollar aver-aging is usually thought of in connection with the small investor, a large number of institutions have long been practitioners— especially those such as pension funds, which deal with a constant flow of incoming cash.
The New Mexico example is significant in that it involves a sum of money already on hand. A look at the special circum-stances shows why the New Mexico Investment Council, responsir ble for investing the money, picked the dollar averaging ap-proach. A majority of the eight council members were described as "amateurs" in investing and were undoubtedly reluctant to take the blame for making a quick, big plunge in the market at what might turn out to be the wrong moment—especially in view of the all-time high level of stock prices at the time. As it hap-pened, the market did rise considerably for some time after the initial decision was made. It is therefore easy to say that the plan was wrong, since some stocks could have been bought at lower prices if a sizable portion of the money had been invested right
24
INVESTMENT MAGIC . DOLLAR AVERAGING
at the start. However, it must not be forgotten that quite a large amount of money was involved, and even an investment pro-fessional would not be eager to take the responsibility for de-ciding that any particular moment might be the appropriate time to invest $159 million. Then too, the council members were in positions of public responsibility, and were thus doubly on the spot.
PRINCIPLE OF DOLLAR AVERAGING
The idea of dollar averaging is to purchase the same dollar amount of a stock or stocks at regular intervals—monthly, quar-terly or annually. Naturally, the method is especially appealing to small investors, who perhaps would not be able to buy stocks any other way, and it has been publicized primarily by the New York Stock Exchange in connection with its Monthly In-vestment Plan, and by mutual fund marketing organizations.
Buying stock at regular intervals seems a completely prac-tical and relatively painless way of accumulating a sizable account. More important, however, the automatic result of buying a fixed dollar amount of stocks at each purchase point—instead of, say, a fixed number of shares—is that more shares are bought at low points, and fewer at high points. By increasing the number of shares purchased when prices are low, and cutting down as prices rise, the investor is constantly working to reduce his average cost, so that the average cost of shares purchased is always lower than the average of the prices paid.
For a clearer picture of exactly what this means, take a look at Table 1, showing results of a hypothetical dollar averaging program using the stock of Bond Stores. Over the 15-year period beginning in 1944, the stock rose sharply from the twenties to a high of nearly 50 in 1946, dropped slowly in succeeding years, and recovered near the end of the period. Our dollar averaging program assumes purchases of $1,000 worth of stock on the last trading day of each year, at an approximate average of the high and low prices of that day, the last purchase being made in 1958. The first purchase is at 221/4, and the last at 211/8, with purchases in intervening years ranging from a high of 391/2 to a low of 131/8. Thus we see the operation of the plan over a complete market cycle, in which stock is bought above as well as below
25
HOW TO PROFIT FROM FORMULA PLANS IN THE STOCK MARKET
the initial price, and the last purchase is near the same price as the first. Neither commissions nor dividends are included in the calculations, and investment of the $1,000 in full and fractional shares is assumed.
TABLE 1
BOND STORES
Dollar Averaging Program, 1944-58
TOTAL | AVG. | |||||||
NO. | NO. | TOTAL | TOTAL | AVG. OF | COST | |||
AMOUNT | SHARES | SHARES | AMOUNT | MKT. | PRICES | PER | ||
YEAR | Invested | ) PRICE | PURCHASED | PURCHASED | INVESTED | VALUE | PAH) | SHARE |
1944 | $1,000 | 22lA* | 44.85 | 44.85 | $1,000 | $1,000.00 | 22.25 | 22.25 |
1945 | 1,000 | 39Y2 | 25.32 | 70.17 | 2,000 | 2,771.72 | 30.88 | 28.5 |
1946 | 1,000 | 31Vi | 31.74 | 101.91 | 3,000 | 3,210.17 | 31.08 | 29.54 |
1947 | 1,000 | 25W | 39.22 | 141.13 | 4,000 | 3,598.82 | 29.69 | 28.34 |
1948 | 1,000 | 17 | 58.82 | 199.95 | 5,000 | 3,399.25 | 27.15 | 25.01 |
1949 | 1,000 | 15% | 65.04 | 264.99 | 6,000 | 4,073.22 | 25.19 | 22.64 |
1950 | 1,000 | 16% | 59.64 | 324.63 | 7,000 | 5,457.55 | 23.98 | 21.56 |
1951 | 1,000 | 14 | 71.43 | 396.06 | 8,000 | 5,544.84 | 22.93 | 20.2 |
1952 | 1,000 | 14 | 71.43 | 467.49 | 9,000 | 6,544.86 | 21.76 | 19.25 |
1953 | 1,000 | 13V6 | 76.19 | 543.68 | 10,000 | 7,125.80 | 20.9 | 18.39 |
1954 | 1,000 | 17Y2 | 57.14 | 600.82 | 11,000 | 10,514.25 | 20.59 | 18.31 |
1955 | 1,000 | 16% | 59.65 | 660.47 | 12,000 | 10,462.87 | 20.27 | 18.17 |
1956 | 1,000 | 14% | 69.57 | 730.04 | 13,000 | 10,494.33 | 19.77 | 17.81 |
1957 | 1,000 | 14Vi | 68.97 | 799.01 | 14,000 | 11,585.64 | 19.64 | 17.52 |
1958 | 1,000 | 21V8 | 47.33 | 846.34 | 15,000 | 17,878.93 | 19.55 | 17.61 |
Last Updated on 11/5/2005
By geoff
♦Adjusted for 2-for-l split in 1945.
The number of shares purchased ranges from 31.74 in 1946, to 76.19 in 1953. Over the 15-year period, a total of $15,000 is invested, and total market value is $17,878.93 at the end of the plan. While this may seem an unexciting result, it should be noted that the stock itself has not only made no progress at all, but has lost ground.
The reason for the satisfactory result despite relatively poor market performance is, as stated above, that at any time after the beginning of the plan, the average cost of shares purchased is lower than the average of prices paid, because fewer shares are bought at high prices, more at low prices. The discrepancy between the average of prices paid and average cost per share is shown in the table. Not shown in the table are dividends, which would have been considerable, amounting to about $1,000 during
26
posted by Geoff at 3:22 AM
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