The Simple Guide To Dollar-Cost Averaging

What is dollar-cost averaging (DCA)? As it turns out, it isn’t just a handy investment strategy to use if you’re looking to build and grow your wealth. It’s also a great way to offset risk, counterbalance market volatility and increase your odds of earning more on your savings over time. Let’s take a closer look at DCA’s meaning – and how to both use it to grow your portfolio and fight back against financial uncertainty.

What Is Dollar-Cost Averaging?

Dollar-cost averaging is both one of the simplest and most powerful investment strategies that you can employ. In fact, millions of professional and armchair investors use it every year as a way to minimize the effects of volatility in the market. Investors who use a DCA strategy first evenly divide the total amount that they’re looking to invest into a series of running payments – then invest each installment at regular intervals. Or, in even simpler terms, when you apply a dollar-cost averaging strategy, you’re effectively committing to invest a certain fixed sum of money for a fixed amount of time and on a running basis. For example, the 15^th of every month.

Employed over a long period of time, dollar-cost averaging can help you alleviate concerns about which stocks to buy. That’s because, rather than investing your money in one lump sum and trying to perfectly time the market, you’re effectively giving yourself multiple opportunities to buy in when the market is (hopefully) low. While it may seem like a scattershot investment strategy at first, make no mistake. History has actually proven it to be a powerful way of (a) minimizing your risk during market downturns and (b) maximizing your odds of turning a profit when markets trend upward.

Noting this, dollar-cost averaging can be a powerful tool to use to offset market fluctuations and employ during bear markets. That’s because it provides additional chances to buy securities at lower prices when other investors may be too afraid to buy – potentially helping you score more deals when stock or other asset prices are heavily discounted.

How Dollar-Cost Average Investing Works

DCA allows investors to invest on a regular basis without having to consider or agonize over how much to invest each month. No matter if your end goal is retirement planning, hedging against risk or simply growing your wealth, this investment strategy can help you secure better purchase prices and offset market fluctuations over an extended period of time.

Unsurprisingly, some of the most common vehicles for dollar-cost averaging include both brokerage accounts and employer-sponsored plans, such as 401(k) plans. Should you elect to use a 401(k) plan, you’ll simply pick a set amount of money to be deducted from your regular paycheck that will go toward your 401(k) account – then determine how much and how often to invest.

To get started with dollar-cost averaging as an investor though, you’ll ultimately need to determine how much to invest and which investment vehicle makes the most sense given your short-term and long-term goals. Likewise, you’ll also have to decide at what intervals to make your investments.

In short, this means having to:

• Determine how much to invest: Pick an amount that you can afford and divide this sum evenly into installments that occur over a set time period (for example 1 – 10 years).
• Figure out where to invest: Dollar-cost averaging works best when it’s being used as part of long-term investment vehicles. That means that in order to make the most of it, your money should remain in accounts for at least 5 years, though ideally you’ll want to put your investments away to grow for 10 or more.
• Decide how often to invest: What interval makes the most sense for you? You can invest weekly, monthly or quarterly as you like – the most important part here is to be consistent about investing. To help make the process simpler and more routine, consider setting up automatic transfers to your 401(k) or brokerage account.

Dollar-Cost Averaging Comparison

DCA investing typically allows you to lower the average cost and average price of your investments. While that may mean acquiring fewer shares of a stock at any given time, it also means potentially securing lower prices and reducing the total purchase price of your assets over an extended period. That said, to get a sense of just how powerful an investment strategy that DCA investing can prove to be, let’s take a look at it in comparison to other investment strategies, such as lump-sum investing, to see how it really works in practice.

Let’s say that you have $30,000 that you want to invest in the stock market. You decide to invest in an exchange-traded fund, or ETF. However, you’re not sure whether to invest all $30,000 as a lump sum now or spread it out in equal amounts each quarter over the next 2 years. Now, let’s compare both strategies to see whether there’s a major difference.

Lump-Sum Investing Example

To begin with, say that (instead of DCA investing) you choose to put in $30,000 all at once at the beginning of the month and will not purchase additional shares of the ETF for the next six quarters. You end up purchasing 240 shares at an average share price of $125.

DCA Investing Example

On the flip side, under a DCA investing strategy, let’s say that you choose to spread out your $30,000 investment over six quarters at $5,000 each quarter instead. As share prices of the ETF fluctuate, so will the total amount of shares that you are able to purchase of your preferred investment products.

Under this scenario, you end up not only acquiring a larger number of shares, but you also manage to do so at a lower average price per share. What this means is that you could potentially earn more on your investments when the share price rises as part of your long-term investing.

The Benefits Of Dollar-Cost Averaging

Dollar-cost averaging allows you to minimize potential downsides of investing while maximizing potential benefits – and works well as a method to diversify investments no matter if you prefer stocks, mutual funds or ETFs. Depending on your risk tolerance and the market conditions it offers a far more reliable strategy than trying to master market timing.

Three key benefits of DCA investing include the fact that it can help you remove emotion from investing, help you adopt a more resilient/long-term investment strategy and help you avoid mistiming the market. Think about it: If you’re constantly hearing about and on edge over swings in the market, you’re more likely to make investment decisions based on emotional reactions. For instance, you might switch between fear (where you’re worried that the market will drop) to greed (purchasing more shares because you think you’re getting a deal).

Using dollar-cost averaging allows you to invest more methodically as well without having to worry about timing the market, instead of relying on gut feelings or instincts as a way to make purchases. Ultimately, it encourages you to look at investments as a more long-term endeavor and take a more stoic and unemotional approach to doing business.

Adopting a DCA investing strategy can also greatly simplify the investment process for those new to stocks, bonds, ETFs and mutual funds. Instead of having to worry about the best time to invest, it enables you to only have to worry about how much and where to invest.

The Drawbacks Of Dollar-Cost Average Investing

Of course, charting the ebbs and flows of the stock market isn’t a sure thing, or something that even the pros can do with 100% accuracy all of the time. Bearing this in mind, a DCA strategy can present some potential drawbacks.

For instance, you might incur additional trading costs since you’ll be investing more frequently compared to lump sum investing. (Although these days, many brokerages are starting to charge less for transactions, with some foregoing fees altogether on certain types of investments.)

Likewise, as you go about DCA investing, you may be risking (or even giving up) any gains that you might have earned if you had invested using lump-sum investing methods before stock prices went up. That being said, again, it’s important to reiterate: The chances of you perfectly timing the market are slim – even experienced investors aren’t great at predicting how the stock market will move from day to day, let alone a more long-term basis.

DCA Investing Pros And Cons

Some upsides and downsides of DCA investing that it pays to be aware of include:

Pros

• Helps simplify and automate investment strategy
• Provides ample opportunities to minimize risk and maximize gain
• Encourages you to have a more long-term investment outlook 

Cons

• May cause you to overlook more lucrative, time-sensitive buying opportunities
• Can sometimes come with more frequent transaction fees attached
• Doesn’t always account for market nuances and complexities

How To Start DCA Investing

Looking to get started with DCA investing? It’s easy to integrate into your investment portfolio or IRA. It would be especially helpful to consult a financial advisor who can help you determine which regular intervals, asset allocations and dollar amounts work best for you. No matter your total investment amount, or asset allocation, dollar cost-averaging can be a helpful tool for wealth generation or retirement planning.

FAQs: What To Know About Investing With Dollar-Cost Averaging Strategies

Answers to several frequently asked questions about DCA investing can be found below.

What’s the meaning of DCA investing? 

Dollar-cost averaging refers to investing by making equal, fixed amount investments in the same assets over a preset period of time at regular intervals. It allows you to simplify the process of investing and opens additional opportunities to buy at lower prices without trying to perfectly time the market.

Is DCA a good investment strategy?

Generally, yes. It’s proven to be a historically sound investment strategy – and one that’s commonly used by millions of armchair and professional investors every day as a way to offset risk. At the very least, it’s a far more advisable one than letting emotions or instincts overrule more logical ways of doing business. That being said, we recommend speaking with a financial advisor before making any major investment decisions.

Is dollar-cost averaging a good idea?

For most individuals, especially those new to investing and the stock market, DCA investing can be a great way to learn about how to grow your portfolio over time.

The Bottom Line: DCA Investing Can Be A Great Tool For Your Investment Portfolio

Think of dollar-cost averaging as the slow and steady approach. DCA investing presents a great way for investors to make fewer emotional decisions and streamline and simplify how they make investment choices. Similarly, it’s also a simple but powerful tool for maximizing gains while minimizing uncertainty, and one that can serve as a hedge against volatility in the market.

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