Welcome to the Bowman financial strategies, retirement bait, simple series. Your host is Erik Bowman, retirement income certified professional and certificate holder of the national social security association.

Dollar cost averaging is a strategy to hedge against market volatility and to potentially enhance returns. In a volatile market it can allow you to purchase shares at a lower cost per share, it removes the emotion and anxiety of when you should invest. So let's go through a quick example that will truly highlight the distinct benefit of dollar cost averaging.

Let's imagine that we have $5,000 to invest and we decide to invest $5,000 split up into five equal pieces of a thousand dollars each over a five-month period or a five week period, depending on how the market's moving you may go into a shorter period of time between investment cycles. But in the first period we see we invest a thousand dollars and the share price is $5 a share, we now own 200 shares. In the second timeframe it's the same price per share, and we own an additional 200 shares. Now in this third timeframe, the price per share has dropped down to $2 a share. So by investing that same thousand dollars, we now gain an additional 500 shares of that holding in period four, we have a price of $4 per share, we purchased 250 shares total. And then in period five, we invest the final thousand dollars back up to $5 a share for an additional 200 shares.

You can see that we've invested the full $5,000. Our average cost per share is $3 and 70 cents. And our total shares that we own now are 1,350. Let's compare that with the exact same market performance by somebody who thought that it was a good idea to throw the full $5,000 in on period one. So the yellow grid represents that scenario. You can see that in period one, the full 5,000 went in, it costs $5 per share, they own 1000 shares total. They've invested the full $5,000, the average cost per share was $5 per share, and the total shares zoned is 1000. 

So, let's just compare that for a second. The dollar cost averaging scenario, the average price per share was $3 and 70 cents and you own over 1300 shares. And in the lump sum contribution scenario, you paid an average price of $5 per share, and you own only 1000 shares.

So, why is this important other than the obvious that you own more shares for the same cost? Well, number one, it can minimize timing risk. That is if you put your money into the market and you thought you had timed it well, and the market ends up going straight down from that point forward, which can happen for sure, you very well could have purchased at the absolute high and over time you won't do as well as an account that dollar cost average into a declining market.

So, the second reason it's important to dollar cost average is it does lower in many cases, the cost per share, and you can use it for contributions and distributions over systematic periodic timeframes to reach your goal. It also develops good investing habits that if you always are thinking about how you're going to distribute your money and how you're going to contribute into your accounts, having a process can keep you from making emotional, emotionally driven decisions that can actually create stress. 

And the last reason is that dollar cost averaging can be extremely efficient. If the account has the ability for auto contributions. So many times, in qualified plans, 401ks, you're selecting your deferral with your employer and you're putting in a specific amount or a specific percentage every single month or every single pay period. By doing this, whether you know it or not, you're gaining the benefit of dollar cost averaging.

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