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Since many people use mutual funds to build wealth over a long period of time, such as retirement savings, a disciplined, regular investment program is an ideal way to meet your financial goals. Dollar-cost averaging is one of the best and simplest methods available to build long-term wealth. While the phrase may sound fancy, dollar-cost averaging merely involves investing a fixed sum of money at regular intervals, regardless of how the market is performing. By following this strategy, an investor will purchase more shares at lower prices and fewer shares at higher prices, the result of which is a lower average cost per share. This concept is best illustrated by looking at a hypothetical example.

Let’s assume that an investor, John, has $10,000 that he wants to invest in the Go-Go Growth Fund. He is concerned, however, that if the market is near a peak he could suffer substantial near-term losses if there is a market correction. As a result, John decides that instead of investing the entire $10,000 at once, he will invest $2,000 each quarter over the next five quarters. His results are shown below.

 

 

Go-Go Fund Share Price

Amount Invested

Shares Purchased

Total Value

Quarter 1

$10

$2,000

200.0

$2,000

Quarter 2

$11

$2,000

181.8

$4,200

Quarter 3

$7

$2,000

285.7

$4,673

Quarter 4

$8

$2,000

250.0

$7,340

Quarter 5

$11

$2,000

181.8

$12,092

 

 

 

 

 

 

Average Go-Go Fund Share Price

$9.40

 
 

Average Share Price Paid by John

$9.096

 
         
 

Go-Go Fund Total Return

 

10.0%

 
 

Total Return for John

 

20.9%

 

 

As shown in the example, dollar-cost averaging enables an investor to increase potential returns from more volatile investments. In fact, market declines can actually benefit the investor who dollar-cost averages.

 

Although dollar-cost averaging is a simple investment strategy, it takes considerable fortitude to maintain it. The first challenge is to set aside money every week, month, quarter, etc. This can be difficult given bills, unexpected expenses, and occasional splurges, but investing starts with saving. One idea is to “pay yourself” first. Set aside the amount of money you want to save each pay check, then pay your bills and provide for necessities. Finally, use whatever money is left for entertainment, vacations, shopping, etc.

 

The second challenge is to continue investing regardless of what the market is doing, which can be very difficult when the market is declining. Dollar-cost averaging is a strategy for long-term investing, so try not to get hung up on the market’s daily movements. Remember that market declines enable you to buy cheaper shares, which may lead to outsized returns over the long haul.