Question

Dollar-cost averaging means that you buy equal dollar amounts of a stock every period, for example, \$500 per month. The strategy is based on the idea that when the stock price is low, your fixed monthly purchase will buy more shares, and when the price is high, fewer shares. Averaging over time, you will end up buying more shares when the stock is cheaper and fewer when it is relatively expensive. Therefore, by design, you will exhibit good market timing. Evaluate this strategy.

Solution

Verified

Dollar cost averaging is not usually a sound investing strategy in many cases because you cannot predict the future movements of a stock price. When employing this specific method you are assuming the stock price will trade somewhere around a normal range for the duration of your investment time. This strategy doesn't give you the most effective range to determine what a good price is, there could be a month or two of extreme volatility where you can end up buying a lot of shares at extremely high prices. The only way that this strategy can work is on a short timescale of around 6 months in which case it might be possible.

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