Consider the same example as above, except this time the share value at the end of each quarter is given by
Current
|
After Quarter
|
After Quarter
|
After Quarter
|
$10
|
$12.50
|
$12.50
|
$16
|
|
|
It is clear that the lump-sum method yields the same profit of $600, but what about the dollar cost averaging method?
Immediately Bob would buy 25 shares at $10 per share. At the end of the first and second quarters, he buys 20 shares at $12.50 apiece for $250 in each case. In the final quarter, the price jumps to $16 per share and for that price he can buy shares. At the end of the year, Bob now owns 25 + 20 + 20 + 15.625 = 80.625 shares which is worth $16 × 80.625 = $, which is not as high a profit as the lump-sum method would have given him, but it's still a sizeable profit.
The dollar cost averaging method is clearly not always superior to the lump-sum method, but it does reduce some of the effects of fluctuations in the market. Statistically, for a market which is 50% likely to go up or down, the dollar cost averaging method, on average, has a higher return than the lump-sum method. However, in an increasing market, the lump-sum method usually has a higher return but can suffer from volatility.