Best long term investment strategy: Cost Averaging Stock Purchase
If you want to know the best long term investment strategy for everyone (not just for financial geeks, banking pros or trading gurus), its cost averaging stock purchase for a long term. This is an easy yet affordable investment to all types of investors. The good thing with this type of investment is that you do not need to know the details of stock trading or money management. All you need to know is how cost averaging works, when you need the money and how much you are willing to invest.
How Cost Averaging in Stocks Works?
Cost averaging is a technique that reduces your risk in stock market. It is because you are always buying it cheap; so you buy more shares when the stock price is cheap and buy fewer shares when the stock price becomes expensive. Supposing you are willing to invest 5000 per month on a specific high cap stocks XYZ. The amount of purchased shares depends only on the price. So if the stock price per year varies from 10, 11.5, 8, 9, 15 then the amount of shares would be:
Amount of purchased shares:
Year 1= 5000/10= 500 shares
Year 2= 5000/11.5 = 435 shares
Year 3= 5000/8 = 625 shares
Year 4= 5000/9= 556 shares
Year 5= 5000/15 = 333 shares
You have noticed you indeed buy fewer shares when the price of stocks increase and buy more shares when it’s cheap. So the total amount of purchased stocks is= 500+435+625+556+333=2449 shares. The total invested up to year 5 is 5000 x 5 = 25000. Therefore on the “average”, you have purchased stocks at a price of:
Average purchased price = Total invested/Amount of shares
Average purchased price = 25000/2449 =10.208 per share.
As you have noticed on the average, you are buying stocks on the “average” which is affordable since you are “cost averaging stocks” purchase.
How much you are willing to invest and when do you need the money?
One of the golden rules of investing is invest early, invest for a long term and investing regularly. The primary reason why you should invest early is to take advantage the power of compounding. Now you know cost averaging, it’s time to put in action. Supposing the rate of return of high valued stocks (high cap and established stocks) is 8% per year. The future worth value is computed as (compounded future worth formula):
F= P (1+ I) ^n
Where n is the number of years, “I” is the rate of return and P is the capital invested. Supposing you want to invest 60000 per year; and you need the money in 10 years. This is how your money in 10 years is calculated:
F1= 60000(1+.08) ^10 (future worth of the money in 10 years invested in the first year) =
F2= 60000(1+0.08) ^9
F3= 60000(1+0.08) ^8
F4= 60000(1+0.08) ^7
F5= 60000(1+0.08) ^6
F6= 60000(1+0.08) ^5
F7 =60000(1+0.08) ^4
F8 =60000(1+0.08) ^3
F9 =60000(1+0.08) ^2
F10=60000(1+0.08) ^1
The total future worth= F1+F2+F3…+F10 = 938729.2478
If you do not invest in stocks and you keep this to yourself, you will only have 60,000 x 10 = 600,000. Or if you are putting this money in a 2.5% time deposit interest bank account, it will only be: 689000. Of course if the inflation is way more than 2% in your own country; your bank interest rate earnings will be eaten away by inflation!
Try computing yourself the above example and use a 40 years investment window instead of a 10 year example (truly long term!) and see how big it will become after 40 years.
Related posts:
- Dollar Cost Averaging Investment Strategy vs. Lump Sum Calculation
- When to use cost averaging strategy in stocks trading investment?
- The best passive income list ideas for Long Term Wealth
- How to use stock investment as your retirement financial plan?
- Direct Stock Purchase Plans List – Great alternative investments