Wednesday, August 7, 2013

Solving your gas problem - Dollar Cost Averaging -

Gasoline - SuperNet? Or PlusNet? - Isn't French great?

Help, I have a gas problem!

Finally, something good to come out of personal finance! I'm talking about solving that embarrassing gas problem you have, where getting gas costs you money, lots of it. For other gas problems, you'll have to read elsewhere.

The principle behind dollar cost averaging (DCA) is prices move randomly up and down, making it impossible to tell if a 5 cent lower price today is a time to buy or will be beaten by a 10 cent lower price tomorrow. Instead of trying to time when to buy, always buy a fixed dollar amount. Buying a fixed dollar amount, leads to buying more when prices are lower and less when prices are higher, giving you a better than average cost.

Enough theory, let’s look at an example:
Say gas prices track the following chart:



Let’s compare buying $25 per day (the dollar cost averaging approach) with buying a fixed volume (20L) per day. Buying is shown on the table below:
Day
Cost / L
Volume Purchased For $25 / day (L)
$25 / day - Cost
Fixed Volume Purchase (L)
Fixed Volume Cost per day
1
$1.00
25.00
$25.00
20
$20.00
2
$1.25
20.00
$25.00
20
$25.00
3
$1.50
16.67
$25.00
20
$30.00
4
$1.25
20.00
$25.00
20
$25.00
5
$1.25
20.00
$25.00
20
$25.00
6
$1.00
25.00
$25.00
20
$20.00
7
$1.25
20.00
$25.00
20
$25.00
8
$1.50
16.67
$25.00
20
$30.00
9
$1.25
20.00
$25.00
20
$25.00
10
$1.50
16.67
$25.00
20
$30.00
Total:

200
$250.00
200
$255.00

The chart below shows quantity purchased with both strategies as well as gas prices in blue.

Note with the DCA strategy:
1.      We are buying more gas when prices are low ($1.00)
2.      We are buying less gas when prices are high ($1.50)

By automatically buying more when prices are low and less when prices are higher, our total cost over the 10 day period is lower, even though we bought the same amount of gas.

But What About Real Life?


In real life, your gas consumption is more or less fixed, so using dollar cost averaging would have you buying gas more frequently in smaller quantities when prices are high and less frequently in larger quanitites when prices are low. Dollar Cost Averaging gives you a simple strategy to manage how much to buy based on the current price, especially when no one knows what future prices are and you have to buy regularly.

2 comments:

  1. How frequently do you have to go the gas station to make this worthwhile? And how does to cost (time, gas, maintenance) of going to the gas station impact the potential benefit?

    Personally, I try and minimize the number of trips to the gas station. They are typically not the nicest of places and the overhead time cost is too high.

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    Replies
    1. Hi Kartik,

      I was hoping to run a real test of this, and track how each strategy would work at the same time. Unfortunately my olde tyme automobile doesn't provide a precise readout of the fuel level, so I cannot really do this.

      Even with a high set purchase amount, you would still have some benefit but not many increased visits to the pump.

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