To understand the potential defensive-investing benefits of dollar-cost averaging, let's take a look at two scenarios involving United States Steel Corp. (NYSE: X).
Thanks to the general downtrend in the market, the May 6 "flash crash," and the rapid subsequent rebound, U.S. Steel shares fell from a 52-week high of $70.95 on April 6 to just $52.81 at the market close on Friday, May 14.
Indications of some new life in the construction sector and an uptick in autos would seem to indicate that steel demand could rise - which would be especially good for U.S. Steel, which supplies both businesses.
You've got $10,000 to work with.
Scenario No. 1: The "All-In" Play
You call your broker (or go to your online account) first thing Monday (May 17) and buy a single block of U.S. Steel stock. Since it opened at $52.25, your $10,000 would have purchased 191 shares (we're ignoring commissions for now).
Turns out your timing was off: U.S. Steel shares continue to fall. In fact, with a 20% stop-loss, you'd have been closed out at $41.80 on June 4, losing roughly two grand in only three weeks. Had you not set a stop, you'd have done a bit better - watching the stock drop to just below $37 on July 2 before rebounding with the rest of the market to close at $48.50 on Aug. 6. Not a disaster, though you'd still be down $716.25 on your 191-share position.
Scenario No. 2: Dollar-Cost Averaging
This time around, you break your $10,000 down into five equal "blocks," or purchases, of $2,000. But, since U.S. Steel opened lower on Monday, you wouldn't have spent the first $2,000 right away. You'd have waited two days as the stock dropped, buying only when it opened higher on May 19, getting 42 shares at a price of $47.65, for an outlay of $2,001.30.
U.S Steel continued to slide - albeit in whipsaw fashion that tracked the major indices - for the rest of May and throughout June. Using the same strategy as the first purchase (wait for an uptick that follows a drop), you would have likely made the following purchases (give or take a few dollars and a few shares):
- May 25 - 45 shares at $43.80, an outlay of $1,971.
- June 8 - 49 shares at $40.65, or $1,991.85.
- July 2 - 52 shares at $38.75, or $2,015.
- July 20 - 49 shares at $40.45, or $1,982.05.
Your final position: 237 shares at a total cost of $9,961.20 - or $42.03 per share.
And the value of your investment at the close on Friday, Aug. 6, when U.S. Steel had rebounded to $48.50 per share, would have been $11,494.50.
That gives you a profit of $1,533.30 - versus a loss of $716.25 had you made the lump-sum investment when you first took a liking to U.S. Steel.
News and Related Story Links:
- Money Morning News Archive:
Defensive Investing Series
- Money Morning:
Defensive Investing: Beware of Municipal Bonds
- Money Morning:
Defensive Investing: Keeping Your Options Open with Covered Calls
When and why did brokerages switch from fixed commissions to negotiated ones?
Financial dictionary - Dollar-Cost Averaging
Dollar-Cost Averaging Pays
Dollar-Cost Averaging With ETFs
Encyclopedia entry: Dollar-cost averaging
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