cost, board, finance

Cost average effect – Ultimate Guide

Cost average effect

The cost average effect is an effect that can have a huge impact on your return if you are using it the right way. And even as a private investor, you can profit from fluctuations. That’s why it is so important to understand how exactly it works. But even more important is to know how to use this effect for your advantage.

That’s why everyone who wants to know more about investing, maybe because he invests in stocks also. And everyone who heard this term already once or twice but has no clue what it means should read this article. I will cover what the effect is and explained it with an example. This will help to understand why you should use this effect to boost your return. In the last step, I will exactly show you how you can use the effect for yourself.

What is the CVA?

The cost average effet already explains himself pretty good trough his name. The probably most obvious term is the average. This is in the name because of the fact that this effect will come into place if you built an average of the stock price.

The second term in the name of the effect is the cost. To be more precise it is the cost per share. But if you would just build an average of the cost per share you wouldn’t have any huge advantage, right?

But you can manipulate the whole average by buying fewer stocks if the price of a stock is high and more when the price of the stock is low.

This may sound very unreliable right now, but you can use a system that works 100% of the time which does exactly this. It is not about knowing when the market will be down and when it will be up because no one ever knows that for sure.

Think about how you would build the estimated average stock price. You would probably buy one stock every time period, let’s just say every month. Then you would, as described earlier, not have any advantage.

But if you would buy stocks for the same amount every time something magical would happen. You would be able to buy consistently fewer stocks every time the stock price is higher.

And also at the same when the price falls you would be able to buy more stocks. This works every time and is not just some knowing when to buy and when to sell a stock.

Example 1

Let me show you how this effect would work out if you had stock prices like these for example:

PeriodShares boughtShares total
1.1,001,00
2.0,671,67
3.1,002,67
4.2,004,67
5.1,005,67

Here you can see a high fluctuating stock price and the number of stocks that you bought. Every time you purchased stocks for $100 and this would add up to the number of stocks. The end price per stock is $100 and you made a profit of $67.

PeriodShares boughtShares total
1.1,001,00
2.1,002,00
3.1,003,00
4.1,004,00
5.1,005,00

Here you can see if you would have bought not every time for $100 and purchased a whole stock every time you would have 5 Stocks valued $500 now. Because you didn’t bought more when the price was down and less when the price was up.

Example 2

To show you the magic from this effect even better let’s have a look at another example:

Here you can see that the price decreased dramatically and never went over 50% of the initial price again. If you know bought into this stock right at the beginning you would have made a huge loss. That is why we want to have look at the cost average affect performance on this chart as well.

PeriodShares boughtShares total
1.1,001,00
2.2,003,00
3.4,007,00
4.8,0015,00
5.4,0019,00
2,0021,00

If you bought stocks for $100 every month again you would end up with 21 stocks overall. These stocks would cost $50 per share and that brings your total stock value up to $1.050.

But you bought stocks for only $600, 6 times for $100. This means that we’re able to make a profit of $450 with a chart that looks that bad on the initial inspection. Pretty awesome, right?

But of course, these examples are very extreme in terms of fluctuation. So normally you wouldn’t be able to make that much money out of this effect. But to show you exactly how this effect work is easier if you have these extreme fluctuations. But you can use this effect I just showed you even if you have less fluctuation.

How to profit through the CVA 

Now that you knew and understood this kind of magical effect there is a big question left, how can you profit from it?

And the answer is as simple as our little example. You just need to buy stocks consistently for the same amount of money every time. But if you do so it is important to understand that not every financial product will give you a better return if you use this effect.

There are even a few scenarios there that will bring you less return if you don’t invest your money right in the beginning.

If you think about a graph that goes, more or less, up the whole time. In this scenario, the use of this strategy would bring you a worse return, because your whole money cant works for you from the beginning on. So if you have really stable financial products like real estate funds or bonds don’t use this technique.

But if you have really fluctuating products like for example gold or bitcoin you can reduce the risk of buying too high really good. If you are interested in bitcoin and other cryptocurrencies you should check out the article I wrote about that topic here:

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Consistency

I order to profit from this effect you need to invest consistently. Because if you are going to buy shares for a different amount every time chances are that you will run into the problem that you invest more when the price is higher then you do when the price is low.

That will compensate for the entire effect we are aiming for which is counterproductive. So if you want to use the cost average effect to profit from it make sure that you chose to invest an amount that you can invest every single month.

If you do so you can be sure that there is no month in that you have to stop investing or month in that you need to quit investing. That will result in the best investing case possible for this effect.

If you want to know why you should invest in the first place, you should check out the article that I wrote about this exact topic:

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Investing

In the end, we have now one question left, and that is which money you should use or investing. If you already have an income of any type this will be a short answer.

Just use the money that you already earn.

But because chances are that spend all this money every single month we actually need to dive a bit deeper into this topic. If you don’t have any money left at the end of the month you need to start planning what you are going to do with your money at the beginning of the month.

This is called budgeting, and it helps you to become rich if you use it the right way. Therefore I would suggest you read the article I wrote about budgeting here:

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Thanks for Reading!

I hope very much you enjoyed my content. If you did so please feel free to have a look at my other articles I linked down below. You also can share your thoughts through the comment section with me and my readers. If you think that more people should have this knowledge you can help to spread it by using the share buttons down below. And in case you want more exclusive content you can subscribe to my newsletter to receive it.

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