Here’s an example: Assume you tell
your bank to transfer $1,000 every
quarter to a broker who is instructed
to use it all to buy shares in a single
stock. At the start of the first quarter,
the market price of the stock is $25,
so your $1,000 buys 40 shares (I’m
leaving out transaction costs to make
the illustration simple). Three months
later, the stock has collapsed to $12.50,
so your $1,000 buys 80 shares. The
next quarter, the stock drops to $10,
so you get 100 shares. Then, it jumps
to $20, so you buy 50. At the end of
a year, the stock price ends where it
began, at $25. You have invested
$4,000 and own 270 shares for an
average cost of $14.81 each. Had
you invested $4,000 all at once at the
start of the year, your cost per share
would be $25.
Of course, in this example, the stock
falls and then rebounds to its original
price. If the stock shot straight up,
you might have been better off making
the all-in investment. But the danger
for investors comes not in a sharply
rising market, when it’s easy to stay
invested, but in a falling market, when
the impulse is to bail out. Dollar-cost
averaging allows you to view your in-
vestments in a completely different
way. A falling stock price is not a ca-
lamity; in fact, it is a boon because it
allows you to own a bigger chunk of
the company.
It’s a rare investment that, at some
point, does not fall below the price
you paid for it. Graham emphasized
both the likelihood and the transience
of such declines. “The bona fide inves-
tor,” he wrote, “does not lose money
merely because the market price of
his holdings declines.” Investors lose
money only if they actually sell at a loss.
The problem, as behavioral econo-
mists including Nobel Prize winner
Richard Thaler have pointed out, is
that investors are “loss averse,” which
means “that they are distinctly more
sensitive to losses than to gains.”
When investors com-
bine loss aversion with
a propensity to check
the dollar value of their
portfolios frequently,
they end up making
mistakes—such as
purging their portfo-
lios of perfectly good
stocks at precisely the
wrong time.A better viewpoint.
When you dollar-
cost average, on the
other hand, you focus
more on the number
of shares you own
than on the daily
prices of those shares.
You think of yourself
as accumulating a big-
ger stake in an excel-
lent business—or, if
you own a broad-based“A SERIOUS INVESTOR,” GRAHAM WROTE, “IS NOT LIKELY
TO BELIEVE THAT THE DAY-TO-DAY FLUCTUATIONS OF THE
STOCK MARKET MAKE HIM RICHER OR POORER.”mutual fund, in a time-tested economy.
“A serious investor,” Graham wrote,
“is not likely to believe that the day-to-
day or even month-to-month f luctua-
tions of the stock market make him
richer or poorer.” He’s right, but how
many serious investors are there if we
define serious as meaning immune to
their own irrational impulses? Not many.
One solution Graham suggests is
“some kind of mechanical method
of varying the proportion of bonds to
stocks in the investor’s portfolio.” If
the market rises, the investor should
“make sales out of his stockholdings,
putting the proceeds into bonds; as
it declines, he will reverse the proce-
dure.” Graham advocates this strategy
because it will give the investor “some-
thing to do” [Graham’s italics]; that
is, it will “provide some outlet for his
otherwise too pent-up energies.”
What Graham is describing is a
form of regular portfolio rebalancing.
Assume you decide on a mix of 60%
stocks and 40% bonds. If, after a few
years, the stock market rises 50% and
bonds are f lat, then just holding on
to your assets gives you a new mix:
69% stocks and 31% bonds. But if you
sell enough stocks and then use the
proceeds to buy bonds, you’ll get back
to 60-40.
I favor rebalancing, but I am a
fanatic when it comes to dollar-cost
averaging. Another advantage to this
strategy is that it is a forced savings
program. If a fixed amount comes
out of your bank account each month
or each quarter, you tend not to miss
it because you never had it to spend.
What a great way to tame your own
worst enemy! ■
JAMES K. GLASSMAN CHAIRS GLASSMAN ADVISORY, A PUBLIC-
AFFAIRS CONSULTING FIRM. HE DOES NOT WRITE ABOUT HIS
CLIENTS. HE OWNS NONE OF THE STOCKS MENTIONED IN THIS
COLUMN. HIS MOST RECENT BOOK IS SAFETY NET: THE STRAT-
EGY FOR DE-RISKING YOUR INVESTMENTS IN A TIME OF TURBU-
LENCE. REACH HIM AT [email protected].38 KIPLINGER’S PERSONAL FINANCE^ 03/2020
INVESTING
THE MAGIC OF DOLLAR-
COST AVERAGINGBy the NumbersDollar-cost averaging allows you to buy more shares
when they are cheaper. In this example, an all-in purchase
in January would net 160 shares at a cost of $25 per share.DateShare
price InvestmentShares
purchasedJanuary $25 $1,000 40April 12.50 1,000 80July 10 1,000 100October 20 1,000 50Total: $4,000 270
Average cost: $14.81