Formula Investment Plans

Formula investment plans are long-term investment strategies based on a fixed formula of adding
dollars to investments, applied over time and without using security analysis or market timing. These
investment plans are especially useful for those who earn a steady income.

There are many formula plans, or variations of them, but the most common formula plans are:

(i) dollar-cost averaging

(ii) constant-dollar investment
(iii) constant-ratio investment
(iv) variable-ratio investment.

Dollar-Cost Averaging

Dollar-cost averaging is a passive investment plan that invests a constant dollar amount per unit of time,
such as a month, taking advantage of the natural fluctuations of market prices over time.

This technique can be used for specific securities or for securities covering a larger swath of the market,
such as exchange-traded funds or mutual funds. With dollar-cost averaging, more shares are bought at a
lower price, when the market is down, than at a higher price, when the market is up.

Dollar-cost averaging can be combined with dividend reinvestment plans (DRIPs), offered by many blue-
chip companies, where the investor can buy company stock directly from the company, free of
transaction costs. There are no transaction penalties for buying less than a round lot of shares (100
shares) and can even be purchased in fractional amounts. Furthermore, all the dividends can be
reinvested automatically if the investor desires. With DRIPs, all the money is invested in the stock,
whereas in buying securities in the market, there may be some transaction costs, and may be higher for
odd lots (less than 100 shares); and since only whole shares can be purchased, there will be some
money left over, unless the share price happened to be an exact multiple of the constant dollar amount
allotted by the investor. The main disadvantage of DRIPs is the lack of diversification, since almost all
DRIPs are offered by blue-chip companies.