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Lesson 13. Choosing a Strategy > Constant Dollar Averaging - Pg. 78

Choosing a Strategy 78 To make the comparison, begin by finding the market price of the stock on the same day each month (say the first) of the previous year and listing it in the second column. Then determine how many shares your regular investment would have purchased each month and write that number in the third column. Next take the total number of shares you would own at the end of the year, add them together, and divide by 12. Do exactly the same with the price of shares, and compare how much the price you paid for each share differs from the average price of the share over the same period. You'll be surprised. Constant Dollar Averaging Frankly, I'm not a big fan of constant dollar averaging. It's just too much work, not to mention too complicated math-wise. But, in the spirit of fairness, you, the investor, should be made aware of it so that you can decide whether it is appropriate for your own needs. Using constant dollar averaging, an investor buys a set number of shares of stock, and adds to and subtracts from the amount invested in that stock to keep the amount of stock constant. As the price declines, the investor adds to the investment; as the price of the stock increases, the investor with- draws excessive cash. Plain English Constant dollar averaging is an investment strategy whereby the investor adds or subtracts cash as necessary to keep the number of original stock purchased constant. Success using the constant dollar averaging strategy is based on the assumption that as the value of your investment increases, you (the investor) collect its proceeds. This makes constant dollar averaging particularly attractive to investors who are looking for income from their stocks. As a novice investor, however, you will be charged with the responsibility of determining on a regular basis the fractions of cash and stock that will keep the stock level constant. In addition, by with- drawing the proceeds of your investment, you will deprive yourself of the power of compound in- terest. I'm not even going to mention the broker fees involved, but suffice it to say they are substantial and require serious consideration in this type of investment strategy. For those reasons, while I'm not against constant dollar averaging, I just can't find a use for it in my own portfolio or in that of the novice investor. The 30-Second Recap · Determining your investment strategy, or how you will select your stock, is rarely as simple as selecting a predetermined set of rules and formulas. Instead, it should be composed of portions of various plans which are most appropriate for your particular situation. · Recommendations are an investment strategy by which investors select their stock based on the outlook of, or the rating given by other people who may be in a better position to evaluate the company and its stock. · Research as an investment strategy implies that the investor makes his or her stock selection based on the information uncovered by any number of sources the investor may consider rele- vant. · Buy and hold is an exceptional investment strategy whereby an investor purchases stock and lets that decision stand for an extended period of time. In addition, buy and hold usually implies that any profits made from the stock such as dividends will be reinvested in subsequent pur- chases of the stock. · Dollar cost averaging is an investment strategy whereby a person systematically invests a pre- determined amount on a regular basis. Through the regular purchases of stock dollar cost aver- aging, a newer investor or one with little money initially can amass a sizeable portfolio over time.