Dollar Cost Averaging – Game #2 (A little something from our history)
In the text, we played a little game together to learn about dollar cost averaging (DCA). Following is another game that will test your understanding. In this game, you will select from one of three investment options. Once again, you will have the benefit of knowing in advance all of the purchase prices and the final sale price of your shares. Below are the figures.
Invest $1,000 per period:
A SHARES B C
$380 2.63 $380 $380
$400 2.50 $360 $80
$420 ______ $340 $50
$440 ______ $320 $100
$460 ______ $300 $190
‘ ______
‘ X$460
‘ ______
‘ $-5,000
‘ =______
What you see above is the price per share for each period for each investment option. So, for example, if you were to choose Investment A, you would invest $1,000 in the first period at a price of $380 per share, meaning that you would purchase 2.63 shares ($1,000÷380 = 2.63). In the second period, you would invest another $1,000 at a price of $400 per share and thus acquire 2.5 shares. You would repeat the process each period until period five, when you would make your final purchase at a price of $460. You would then sell all of your shares at the fifth period’s price of $460. To calculate your gains or losses, you would then subtract your total investment amount of $5,000 from the total sale proceeds.
Okay, now it’s time to make your choice. Before looking ahead, choose Investment A, Investment B, or Investment C.
Now look at the calculated results:
‘ A B C
$380 2.63 $380 2.63 $380 2.63
$400 2.50 $360 2.78 $80 12.50
$420 2.38 $340 2.94 $50 20.00
$440 2.27 $320 3.13 $100 10.00
$460 2.17 $300 3.33 $190 5.26
‘ 11.95 14.81 50.39
‘ X $460 X $300 X $190
‘ =5,499 =4,443 =9,574
‘ $-5,000 $-5,000 $-5,000
‘ $499 Gain $<557> Loss $4,574 Gain
If you are like most people, you probably chose Investment A because it looked safe. And it was, while generating a modest gain of $499. Investment C is typically the least chosen option, and understandably so at first glance because the ending price was at only half of the starting price. And yet it was somehow the most profitable. This once again is due to the phenomenon produced by dollar cost averaging (DCA), whereby a larger proportion of shares is purchased during the periods when prices are low. This also causes the average cost per share purchased to be lower than the average price per share.
As in the case of the other DCA example in the text, we must acknowledge that such wide variations in share prices are highly unusual when considering a balanced portfolio that reflects the American economy. However, in this particular case, we are in fact looking at our own history. Investment C is actually the Dow Jones Industrial on selected days during the Depression years of 1929, 1931, 1933, 1935, and 1937. It’s interesting to note that while the gain for Investment C was $4574 in 1937 with the Dow at 190, the Dow later reached 1,000 in 1972 and closed at 40,000 for the first time on 5/17/24. At that price level, those same 50.39 shares that cost $5,000 would be worth over $2 million.