Tuesday, August 9, 2016

What Is Dollar Cost Averaging?

When you buy shares at different prices on various dates the result is an amazing thin called the 'Dollar Cost Averaging' having a profound impact on your portfolio and returns on your investments.

Dollar cost averaging is a nice sounding term for a simple concept of weighted average cost. let us see the example from our educational portfolio 'Portfolio 2K15'.

The ‘Dollar Cost Averaging’ is done only a way of Reporting. Your port folio shows the average holding cost at a glance for your convenience. However when you click on the name of the scrip the detailed page opens showing the various purchases on the various dates at various prices. Therefore I would say that the actual data and records remain intact and only in the report the holdings are dollar cost averaged.

If we examine my favourite scrip NMDC Ltd., in April 2016 we are holding 444 shares at weighted average holding cost of Rs.107.58. If we go deeper into the detailed purchases on various dates it will look as shown in the following table:

We can see that beginning with a price of Rs.130.48 in March, 2015 when the market was high, we were able to buy the shares at as low a price as Rs.81.35.

The beauty of dollar cost averaging is that over a very, very long period of time of say three to four decades, one is able to purchase the scrips at various levels, from very low and the weighted average cost is optimal, making timing the market, which is extremely difficult, irrelevant.

The second advantage is one can achieve spectacular dividend yield through dollar cost averaging. NMDC is quite generous in paying dividends and the yield is generally 10%, which on a tax free basis is simply superb. Suppose after 20 years the price of the share is Rs.800 and the dividend yield at that time is 10% it means the company paid a dividend of Rs.80 per share. Such a dividend on the 444 shares purchased at an average cost of Rs.107.58 is yield of 74.36% per annum. If you consider the capital appreciation, your 444 shares bough at and average Rs.107.58 are valued Rs.800 apiece, giving a return of 643% in twenty years. 

From the above it becomes clear how Riches are built on stock markets through prudent investments over long periods of time through dollar cost averaging. 

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