Dollar Cost Averaging

Over a period of fluctuating prices, dollar cost averaging produces an average cost per share that is:

1. A.Lower than the average of the purchase pricesCorrect - the math favors the investor when prices vary.
2. B.Higher than the average priceThis is the reverse of what the method produces. Investing a fixed dollar amount buys more shares when prices are low, and those cheaper shares carry more weight in the total, pulling average cost below the average price.
3. C.Always equal to NAVEach periodic purchase is made at whatever price prevails that day, and in a loaded fund that price is the offering price rather than NAV. The result is a blend of many different prices, not any single day's net asset value.
4. D.Exactly the average priceThis would be exactly right under a different plan: buying the same number of shares each period does produce an average cost equal to the average price. Fixed dollar investing changes the weighting, since more shares are acquired at low prices, so the average cost comes out below the average price.

Why: Because fixed dollars buy more shares at low prices and fewer at high prices, the average cost is lower than the simple average of the prices paid.

A payroll-deduction investment plan is a practical way to apply:

1. A.Market timingMarket timing means varying when and how much to invest based on a forecast of prices. A payroll deduction does the opposite: the amount and the date are fixed in advance precisely so no forecast is required, and the investor ends up buying more shares when prices are low.
2. B.Dollar-cost averagingCorrect - fixed periodic investing.
3. C.LeverageLeverage means investing with borrowed money to magnify returns. A payroll plan invests wages the employee has already earned, so there is no borrowing and no amplification of gains or losses.
4. D.Tax-loss harvestingTax-loss harvesting is a selling strategy: realize a loss to offset gains elsewhere. A payroll plan only buys, and doing it inside a retirement account would make harvesting pointless anyway, since losses there produce no deduction.

Why: Investing a fixed amount each pay period is dollar-cost averaging.

An investor bullish long-term but expecting a short-term dip may:

1. A.Sell everything to cash permanentlyThe word permanently is what breaks this. A long-term bull expects the recovery, so a permanent exit converts a temporary dip into a realized loss and abandons the very thesis the investor holds.
2. B.Stop investing foreverThis discards a long-term bullish outlook over a move the investor already expects to be brief. A belief that prices will be higher later is an argument for continuing to invest, not for stopping.
3. C.Short the market heavilyShorting positions the account against the long-term view the investor actually holds, and doing it heavily piles unlimited risk onto a short-term call. Letting a near-term forecast override the long-term thesis inverts the priority.
4. D.Dollar-cost average or buy on weaknessCorrect - accumulate through the dip.

Why: Dollar-cost averaging or buying on weakness lets a long-term bull add over time despite short-term dips.

An investor making equal monthly contributions regardless of share price is using:

1. A.LeverageLeverage magnifies exposure by adding borrowed money to the investor's own. This investor commits the same modest sum out of current income each month and takes on no debt, so total exposure grows arithmetically rather than being multiplied.
2. B.Market timingThe phrase regardless of share price rules this out. A market timer is doing the opposite, watching price to decide when to buy and how much, while this investor has removed price from the decision entirely and simply lets the fixed dollar amount buy whatever it buys.
3. C.Dollar-cost averagingCorrect - fixed periodic investing.
4. D.Sector rotationSector rotation shifts money among industries as the economic cycle turns, so it requires ongoing judgment about which sector leads next. The strategy in the stem involves no such choice and does not even specify what is being bought, only how much and how often.

Why: Investing a fixed dollar amount at regular intervals is dollar-cost averaging.