What is dollar cost averaging?

An inherent risk of mutual funds is the fluctuating price of shares. Shares that were purchased on Monday for $9.50 may be selling for $9.35 on Tuesday or $9.58 on Thursday. These fluctuations occur because the prices of the securities held by the fund will change based on activities in the securities markets.

Dollar-cost averaging is one way to smooth out the effect of market fluctuation on the cost of an investment and occurs when investors make contributions to their account on a regular basis. Dollar-cost averaging involves investing the same amount of money at regular intervals, usually monthly. A convenient way to do this is for an investor to have money transferred from their bank account each month for the purchase of mutual fund shares.

The result of dollar-cost averaging is that more shares are purchased when the price is low and fewer shares are purchased during periods of higher prices. In the end, the average cost per share should be lower than the average share price. By investing through dollar-cost averaging, the investor lessens the risk of making a lump sum purchase at an inopportune time. See the chart for an example.

There are many ways an investor can take advantage of dollar-cost averaging. The most common method is payroll deductions for an employer sponsored retirement plan, such as contributions to a 401(k) plan funded through mutual funds. A predetermined amount is deducted from an employee's paycheck on a monthly basis and shares are purchased at that day's offering price. The principle of dollar-cost averaging may also be applied to after-tax accounts.

A person may elect to have an amount automatically withdrawn regularly from his or her bank account through electronic funds transfer (EFT). The transfer may be scheduled to occur every month, quarterly, or any way that is convenient to the investor.

It is important to remember that the value of shares will fluctuate. Fund shares, when redeemed may be worth more or less than their original cost. Dollar-cost averaging does not assure a profit or protect you against a loss in declining markets. Also, because such plans involve making continuous investments regardless of fluctuating share prices, you should consider your financial ability to continue making purchases through periods of high and low prices.

Hypothetical Illustration

This hypothetical chart is for illustrative purposes only and is not intended to represent or imply the actual performance of any specific investment. The hypothetical chart may not be used to project or predict investment results. It is important to note that any investment involves risks that may result in the loss of principal. There is no guarantee that the strategies illustrated will produce positive investment results.

After investing for 12 months, using this example, the average cost per share is lower than the average price and the current cost per share.

This table uses hypothetical figures to illustrate the effects of dollar-cost averaging. The figures are not meant to represent any actual share prices of any of the funds found in the State Farm Mutual Fund Trust.

State Farm VP Management Corp Risk/Important Disclosures. State Farm Mutual Funds Prospectus. The State Farm College Savings Plan Enrollment Handbook (PDF 553 KB) .

It is important to note that there is market risk involved when investing in mutual funds, including possible loss of principal.

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AP2008/10/1481