Diversification and Dollar Cost Averaging

You probably remember our discussions of the importance of diversification when investing.  It follows the idea of "Don't put all your eggs in one basket" -- meaning if you put all of your eggs [investments] into one basket, and that basket gets destroyed, you lose everything.  By putting a some of your eggs in one basket [savings], some of your eggs in another basket [individual stocks], some of your eggs in another basket [mutual funds] and some of your eggs in another basket [real estate] -- you are more stable in the long run.

Today we are going to begin discussing Dollar Cost Averaging -- a process by which you buy a regular dollar amount worth of something [i.e. a mutual fund] at regular intervals [i.e. monthly] regardless of the price at that time.

For example: Imagine that you are going to invest $100 per month in a certain stock.  This month the stock is at $10 per share so you will be able to buy 10 shares.  Next month the stock is at $11 per share so you will only be able to buy 9.09 shares.  The following month the stock drops to $9 per share so you are able to get 11.11 shares.  In month 4 the stock is up to $16 so you can only afford 6.25 shares.  You now own 36.25 shares of stock worth an estimated  $580 -- and you have invested only $400.  Obviously if stocks suddenly dropped back to the $10 per share where you started, your stocks would only be worth $362.50, but the stock market has a pretty strong track record of upward movement over time.  Even so, don't forget the concept of diversification... and don't invest money you can't afford to lose.

Now I always suggest consulting multiple sources of information prior to investing.  Here's an example of reasons NOT to use Dollar Cost Averaging.  I disagree with his reason, but it's good to listen to varied opinions.