An Explanation of Dollar Price Averaging Versus Simple Averagingby InvestorGuide Staff
Never confuse dollar price averaging with simple averaging. For instance, let's say an investor purchased 1,000 shares of Microsoft stock at $40 per share at the first interval and another 1,000 shares of stock at the next for $25 a share. That would make the total investment $65,000 and the average stock price $32.50. However, this is not dollar cost averaging - it is simple averaging. The average cost of the stock will not trend towards the current market value if you do not remain consistent in your investment strategy. Using dollar cost averaging, a person would invest a fixed amount - say $33,000 per interval. Thus, when buying the same Microsoft stock at the first interval, a person would end up with 825 shares of stock at $40/share and 1320 shares at $25 each. This adds up to 2,145 shares and an average cost of $30.75 - closer to the current market value of $25 than the simple averaging strategy.