Highlights of this day in history: Allies mark VJ-Day as World War II effectively ends; Woodstock begins; France’s Napoleon Bonaparte born; India gains independence; Blast hits Omagh, N. Ireland; ‘The Wizard of Oz’ premieres in Hollywood. (Aug. 15)AP, AP
Answer: One strategy I like to use when I’m afraid a stock could be due for a pullback is called dollar-cost averaging. You can apply this to Microsoft or any other stock you’re thinking of investing in.
Dollar-cost averaging simply means buying a set dollar amount of stock at regular time intervals in order to build a position. For example, if you want to buy $6,000 of Microsoft stock, you could invest $2,000 today, another $2,000 in three months and the final $2,000 in six months.
Here’s why it works: The obvious reason is the one you stated – if Microsoft stock goes down over the next few months, you’ll be able to take advantage and buy some shares at a lower price. On the other hand, even if the stock doesn’t go down over time, dollar-cost averaging ensures that you’ll get a mathematically favorable price.
As a simplified example with round numbers, let’s say Microsoft trades for $100 today (it’s actually about $110), so your $2,000 would buy 20 shares. In three months, the stock trades for $80, so you would buy 25 shares with the second $2,000. And in six months, Microsoft has shot up to $125, so you’d buy 16 more shares with the final $2,000.
You would now have 61 shares of Microsoft at an average cost of $98.36 each. Meanwhile, the average stock price among the three days you made your purchases ($100, $80, $125) is $101.67. By averaging into a position, you’ll ensure that you’re getting a below-average price and will also protect yourself in the event the stock drops.
Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. Matthew Frankel has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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