Let me try to explain what I mean by DCA having inherent problems built in it.On the url are links that explain it better than I can, but they are on if you should DCA in to a stock over 12 months or Buy at once! I am more interested in what someone is doing with a 401k, most people try to max out their 401k, they put in $100 and the company puts in $40, or what ever percent. Most people get several mutual funds, a bond fund or two, and a money market fund to pick from. They put most of their money in the mutual funds, a little amount in the bond fund and none in the money market fund.They put a set amount into each fund no matter what the fund is doing (DCAing). I think there is a better way! Ok back to the problems of DCA. Lets say you are just starting out the first two months.The first month the fund is $15, and the next month only $10. The first month you invest $100 and get 6.66 shares and your average cost is $15. The next month the stock is at $10 and your 6.66 shares are only worth $66.66, a loss of -33.33%. Now what happens when you add the $100 for the second month? $100 divided by $10 is 10 shares, for a total of 16.66 shares Worth $166.66. Now what is our percentage of loss? $166.66 minus $200 divided by $200 equals -16%loss, we have still loss the same amount of money, it just looks better. What about our average cost, well that has gone down as well. It was $15, it now is $200 divided by 16.66 shares, equals $12 a share, so once the fund recovers to $12 we will be even and ready for a profit. I know, you are thinking I thought he said DCA had some problems. It does, on to the next example. Lets say you have been investing for a year ($1200) and have a average cost of $15, 80 shares. And now the price drops to $10, again you have a loss of 33% your 80 shares are now worth only $800. Now what happens when we add that $100 to it? The $100 buys 10 shares, so we now have 90 shares. We have invested a total of $1300 in 90 shares worth $900. Our loss is now only $900 minus $1300 divided by $1300, equals -30%loss.It did not get reduced nearly that much. What about the average cost, well it went down but not as much as before, $1300 divided by 90 shares equals $14.44 average cost. In this example DCA did not do as well as in the first example, why not. It is a mater of ratios. In the first example we had $100 and added $100 to it, we added 100% to it, or doubles the amount invested. In the second example we had $1200 and added only $100 to it, we added only 8.33% to it. If we could have added a larger amount to it would have done better. The next question is where will we get the extra money to do that we were already investing at maximum each month. If you have excel you can see this in my spread sheet DCAGainLoss.xls just stick in your own stock prices, and the amount of money to invest each month. Play with it and see what the graphs do.
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