What is “Dollar Cost Averaging” and why does it work?
By Bob Pellerin and K.C. Grainger, CanadianMineAnalysis.com
1. The cyclical price action of the markets often brings many investments into a traditionally attractive buying range. During the downside moves, many stocks can be found selling at prices that have proven over the years to be excellent buying opportunities. The most successful investors make their commitments after a severe decline in the prices of these stocks while pessimism is still running high. Simply stated, they take advantage of the market’s cycles!
2. Dollar cost averaging is a method of investing equal amounts of money regularly and periodically over specific time periods (such as $2000 monthly for 12 months) in a particular investment(s) or generally buying more shares of the same stocks when they decline in price. By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high.
3. Why it works? The primary benefit is to lower the average cost per share of the investment, giving the investor a lower average cost for the shares purchased over time. Investors should note that Junior small cap mining stocks have enormous price volatility both up and down, so if the fundamentals of a stock(s) still justify investment, it merits even more attention at the lower prices. It can very effective for the Junior mining stocks as stocks often lose 80% to 90% in value before turning up again.
4. Why for another reason? In junior mining stocks today, there is virtually no comprehensive research for the vast majority of junior mining stocks. With no research support, firms do not have market makers helping to “support and maintain a bid and ask market” which would have them positioning shares and often preventing extreme declines. That is rare today, so juniors decline much more than in the past. However, that extra price weakness can give the ‘dollar cost average investor’ the opportunity to accumulate shares at even lower prices.
5. While we have huge volatility in the mining stocks and witness large price declines in them; this is a strategy that very few investors consider. Yet, it can be incredibly profitable. After doing the required analysis and buying a stock, the investor takes advantage of declines as well by buying more shares at lower prices when and if they occur. A decline is often not a time to complain but perhaps to take advantage of the “sale on a particular stock.” Also watch for officers and directors buying the companies’ shares when they are down. That is another piece of helpful evidence.
6. Many fund managers regularly dollar cost average as regular cash inflows by their investors are usually invested in their same universe of stocks. It is not that they want the shares to decline in price but by investing when their stocks are down in price, they have the opportunity to enhance portfolio performance rather than just wait for the return up in price.
7. For example, let’s say that we are looking at a Junior mining stock XYZ Mines and an investor does the required due diligence and buys 5000 shares of XYZ mines at .60 cents at a cost of $3000. Perhaps XYZ had already declined from $1.50 a share and at .60 cents, it seems to be an undervalued stock, so the investor buys it. Then, the investor sits and waits……and later sees it decline to what may be incredibly undervalued at .15 cents. That happens regularly with small cap mining stocks. With less research coverage and sponsorship today, it is even more likely as many stocks simply “slip through the cracks” and drop to undervalued price levels.
At the same time, “XYZ” mines, even at .15 cents, may have a cash position of over $3,000,000 which for this example we will say is .10 cents per share. The value of the company’s gold reserves in ground (we will give them a value of $10 per ounce for in ground gold) may give us an asset value of $2.00 per share for those gold reserves. XYZ may also have good exploration results on another project and current insider buying of the XYZ’s shares by the management is occurring as well. Those fundamentals may indicate that we may have a “sale on the stock” that investors could consider taking advantage of.
So the investor buys another $3000 worth of the shares and gets another 20,000 shares. The average cost for all the shares purchased by the investor drops to .24 cents. A return back up in XYZ’s price could be quite profitable. Naturally there are never any guarantees in investing, risk is always there. But few people will ever do that.
8. Now you may ask as “how many investors do actually engage in “dollar cost averaging.” One study showed less than 2% to 3% of private investors ever engage in “dollar cost averaging.” That will never change.
The old investor poem goes like this: “When prices are high, they run to buy, when prices are low, they let them go.” Believe me that will never change.
Source: The “Canadian Mine Analysis” a research site with a focus on undervalued Canadian mining stocks. Readers can register for a free news newsletter featuring the latest news on mining and market movements at www.CanadianMineAnalysis.com.
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