Dollar Cost Averaging: Taking Some Volatility Out of the Portfolio

 


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One of the holy grails of investing is the ability to achieve a decent return without volatility. After all, I think we all learned somewhere along the line that the shortest distance between two points is a straight line. To say we are a long way from achieving that goal is certainly an understatement. But, until we do achieve that goal, dollar cost averaging can help.

Simply put, dollar cost averaging is investing at specific intervals over a specified period of time. Instead of buying at a single share price with a lump sum investment, dollar cost averaging buys when prices are both high and low, thus averaging the share price.

There is some argument that dollar cost averaging (DCA) can actually inhibit the return on investment, and I have no disagreement with that argument. If a purchase is made when the share price is low and the price soars in the future, the results will show better than when purchases are made at a higher average price. Secondly, short-term, dollar cost averaging often does not give the process enough time to show its true colors.

Thus, in order to truly benefit from dollar cost averaging, an investor needs to understand that it is a long-term process, and more a function of decreased volatility than of absolute return on investsment.

Looking at returns over a 1 year, 3 year, and 5 year period is helpful in determining investment research. We must remember, though, that these are only “frozen” snapshots of investment returns at specified intervals of time. With dollar cost averaging, our need for funds is not only at the end of these specified intervals, it continues throughout the entire period. This lends credence to the continual need for decreased volatility.

For those investors who practice asset allocation, dollar cost averaging can be a great way to continually rebalance a portfolio. Instead of buying and selling to rebalance, investing on a regular basis (monthly, quarterly, etc. ) can bring the allocation percentages back to their desired levels. Because trading is kept to a minimum, this strategy also manages the tax bite on potential gains.

There is a good chance that you may already be participating in a dollar cost averaging program. Monthly 401(k) contributions and quarterly dividend reinvestment plans are two prime examples of dollar cost averaging. Mutual funds also have “systematic deposit” programs that are set to automatically sweep funds from checking or savings accounts on a regular basis.

Naturally, there is no guarantee that you’ll actually profit from dollar cost averaging. This strategy does not protect against losses in a declining market. Such a plan involves continuous investments in securities regardless of fluctuating price levels. Before engaging in a dollar cost averaging strategy, you should consider your financial ability to continue purchasing through periods of low price levels.

The strategy also isn’t a substitute for investment research. Bad investments will always lose money whatever your approach.

But if you are into investing for the long term and you want to take some volatility out of your portfolio, take a look at dollar cost averaging.

Glenn (“Chip”) Dahlke, a senior contributor to the Living Trust Network, has 28 years in the investment business. He is a Registered Representative of Linsco/Private Ledger and a principal with Dahlke Financial Group. He is licensed to transact securities with persons who are residents of the following states: CA. CT, FL, GA, IL. MA, MD. ME, MI. NC, NH, NJ, NY. OR, PA, RI, VA, VT, WY.

If you have any questions or comments, Chip would love to hear from you. You may contact him by email at dahlkefinancial@sbcglobal.net . You may also contact him at the Living Trust Network. It's URL is http://www.livingtrustnetwork.com .

Copyright 2005. Living Trust Network, LLC. All Rights Reserved.

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