Average Cost

A customer holds shares of a mutual fund and wants each share sold to use a single blended cost figure covering all her purchases in the fund, rather than tracking the cost of each individual purchase lot separately. What must she do to use this treatment?

1. A.She must elect the average cost method for the fund, which the fund or firm calculates by blending the cost of all shares in the position into a single per-share average, an election available specifically for mutual fund shares and applied prospectively once made.Correct. Average cost is an election specific to mutual fund shares, applied prospectively once made.
2. B.Nothing -- average cost is applied automatically and irreversibly to every mutual fund position without any customer election being necessary.Wrong. Average cost is not applied automatically; it requires a customer election.
3. C.She must request average cost treatment separately for each individual sale, since the election does not carry forward to future sales of the same fund.Wrong. The election generally applies prospectively once made, not transaction by transaction.
4. D.She must convert her mutual fund shares into individual equity shares of the fund's underlying holdings before average cost treatment becomes available.Wrong. No conversion of the mutual fund shares into underlying equity holdings is required or relevant to this election.

Why: Average cost is not the automatic, default treatment for a mutual fund position -- it is an election a customer makes specifically for mutual fund shares, under which the fund or firm blends the cost of every purchase into a single per-share average rather than tracking each lot's individual cost separately. Once elected, this treatment generally applies prospectively to future sales from that position, rather than being something the customer re-requests transaction by transaction.

A client invests a fixed 500 dollars every month into the same mutual fund regardless of its price. Over time this strategy will...

1. A.Buy the same number of shares each monthA fixed dollar amount buys varying share counts as the price changes.
2. B.Guarantee a profit over timeDollar cost averaging does not guarantee profit; the fund can still decline.
3. C.Eliminate market risk entirelyIt smooths entry cost but does not remove market risk.
4. D.Produce a lower average cost per share than the average price paidCorrect — fixed dollar investing buys more shares when prices are low, lowering average cost.

Why: Dollar cost averaging buys more shares when prices are low and fewer when high, producing a lower average cost per share than the average of the prices paid.

An investor contributes $500 monthly to a fund regardless of price. Over periods when the share price fluctuates, dollar-cost averaging results in:

1. A.A guaranteed profit over any full market cycleWrong. DCA cannot guarantee profits in declining markets.
2. B.An average cost per share below the average of the share pricesCorrect. The harmonic-mean effect of fixed-dollar purchases produces this result.
3. C.Fewer shares purchased when prices are lowWrong. Fixed dollars buy MORE shares at lower prices.
4. D.Elimination of market risk from the portfolioWrong. DCA times purchases; it does not remove market risk.

Why: Fixed-dollar investing buys more shares at low prices and fewer at high prices, producing an average cost per share below the average of the prices paid, though profits are not guaranteed. Citation: standard DCA mathematics, NASAA Series 66 outline. Takeaway: average cost < average price; no profit guarantee.