Quote from HolyGrail:
That makes no sense to me. Yes you will eventually be in at the bottom. but at what average cost if it takes another year for the bottom to finally be hit (if that short of a time period)?
Thanks for the replies.
It is not as bad as you think.
Lets follow Ryan Johns example from his money management book.
Also, see bold at the bottom.
The simplest definition to cost averaging is to add onto a losing
position. There are exceptions, but this is the most common use of the
method. For example Joe Trader invests $5,000 in a mutual fund at
$17.00 per share. Most mutual funds allow fractional shares and
therefore Joe Trader has 294.11 shares (provided there is no load). As
time moves along (as it normally does), the price of the mutual fund
slowly drops. Several months later, Joe Trader decides to invest an
additional $5,000 into the fund at $14.80 per share. Because of the
drop in price, Joe is able to purchase 337.83 shares of the fund with
the second $5,000 investment. Joe now owns 631.94 shares of this
mutual fund at an average cost of $15.82. Joe�s average price for each
share of the mutual fund dropped from the original price of $17.00
down to $15.82. Thus, the price of the mutual fund does not have to
move back up to $17.00 for Joe to recoup the losses from the initial
$5,000 investment, it only has to move up to $15.82.
$15.82 avg. price x 631.94 shares = $9,997.29
(if we carry the decimals further it will total $10,000)
$10,000 total investedl631.94 total shares = $15.8242 avg. share price
This can go on for a considerable time.
If the share price of the
fund continues to drop, Joe may have a plan to invest an additional to $12.00 per share, Joe will have invested as follows:
$1,000 at $14.30 p/s = 69.93 shares Total shares = 701.87
$1,000 at $13.80 p/s = 72.46 shares Total shares = 774.33
$1,000 at $13.30 p/s = 75.19 shares Total shares = 849.52
$1,000 at $12.80 p/s = 78.13 shares Total shares = 927.65
$1,000 at $12.30 p/s = 81.30 shares Total shares = 1,008.95
Joe now has $15,000 invested in this fund at an average cost of
$14.87 per share. For Joe to recoup the losses, the fund has to move
up to $14.87 per share. If the fund moves all the way back up to
$17.00, then Joe will have profits of $2,152.15, or a 14.34 percent
gain on his investment.
If Joe did not cost average, the investment
would simply be a breakeven.
