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Dollar cost averaging (DCA) is an investment strategy where you invest a fixed dollar amount into securities at regular intervals, regardless of market conditions. Rather than trying to time the market, DCA spreads your purchases over time, which may help reduce the impact of volatility on your overall portfolio.
With DCA, you choose the securities you want to buy and a fixed dollar amount to invest on a schedule, whether monthly, biweekly, or another interval, and then automate those contributions so they happen consistently.
Read on to learn more about the DCA meaning, how this investment strategy works, and the pros and cons to be aware of.
Key Points
• Dollar cost averaging (DCA) is an investment strategy that helps manage volatility by investing a fixed dollar amount regularly.
• DCA involves buying securities at regular intervals, regardless of market prices, to avoid trying to time the market.
• Dollar cost averaging works by investing the same amount consistently, resulting in buying more shares when prices are low and fewer when prices are high.
• The strategy can help investors stay the course and avoid emotional decision-making based on market fluctuations.
• While dollar cost averaging offers benefits like consistency and automation, it may yield lower returns compared to lump-sum investing in a rising market, and it does not replace the need for periodic portfolio rebalancing.
What Is Dollar Cost Averaging (DCA)?
Dollar cost averaging is an investment strategy where you buy a fixed dollar amount of an investment on a regular basis, such as monthly. The goal is not to invest when prices are high or low, but rather to keep your investment steady and repeatable, and thereby avoid the temptation to time the market.
Because you invest the same dollar amount each time, you automatically buy more shares when prices are lower and fewer shares when prices are higher. Without a set schedule, behavioral finance research suggests investors often let emotions drive decisions, buying less when prices drop out of fear, and more when prices rise out of optimism. DCA helps to remove that impulse by making contributions automatic and consistent.
How Dollar Cost Averaging Works
Dollar-cost averaging works by investing a fixed dollar amount in an investment at regular intervals, regardless of the investment’s price. For an investor, it may be as simple as investing $5 in Fund A every other week (some investors might even think of Fund A as their DCA Fund), or something similar, no matter what’s going on in the market.
That way, you’re investing the same amount whether the market goes up, down, or sideways. For example, if you invest $100 in Fund A at $20 per share, you get 5 shares. The following month, say, the price has dropped to $10 per share, but you stay the course and invest $100 in Fund A — and you get 10 shares.
Over time, the average cost of your investments — the dollar amount you’ve paid — may end up being a little lower, which can benefit the overall value of your portfolio.
Dollar Cost Averaging Formula
When using a dollar cost averaging strategy, the formula for determining the average price paid per share of an investment over a certain period of time is simple:
Total Amount Invested / Total Number of Shares Owned = Average Price Paid Per Share
Dollar-cost averaging works on the assumption that prices naturally rise and fall over time, so investors automatically buy more shares when prices are low and fewer shares when prices are high.
As a result, a dollar cost averaging strategy may help investors reduce the average share price they pay over time, potentially lowering their cost basis in investments. A common real-world example of dollar-cost averaging is the automatic, recurring contributions made through 401(k) retirement plans, where a fixed amount is invested from each paycheck over many years regardless of market conditions.
That said, dollar cost averaging may not always reduce the average price paid, such as when the price of an investment rises steadily. Dollar-cost averaging can also carry more risk when applied to a small number of stocks rather than a diversified portfolio, because an investor may continue buying shares even as a single stock’s price falls steadily due to a deteriorating business.
Example of Dollar Cost Averaging
Here’s an example of how dollar cost averaging might look in practice.
Investor A might buy 20 shares of an exchange-traded fund (ETF) at $50 per share, for $1,000 total. This would be investing a lump-sum, rather than using a dollar cost averaging strategy.
Investor B, however, decides to use a dollar cost averaging strategy.
• The first month, Investor B buys shares of the same ETF at $50/share, but spends $300 and gets six shares.
• The next month the ETF price drops to $30 per share. So Investor B once again invests $300 and now gets 10 shares.
• By the third month, the ETF is worth $50 per share again, and Investor B’s regular $300 investment gets them six shares.
Investor B now owns 22 shares of the ETF, at an average price of $40.90 per share and a total cost of $899.80.
Or, to use the DCA formula: $899.80 / 22 = $49.90
By comparison, Investor A, paid $1,000 ($50 per share for 20 shares) in one lump sum.
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Benefits and Disadvantages of DCA
Dollar-cost averaging has potential advantages, but it also comes with tradeoffs worth understanding before you commit to the strategy.
Dollar Cost Averaging Benefits
One main benefit of DCA is that it requires you to stay the course, regardless of volatility. It keeps you from trying to time the market and trying to figure out how to know when to buy a stock. By investing the same amount of money every month, you will buy more shares if the market is down and fewer shares if the market is up. You’re not investing with your emotions, which can lead to impulsive choices.
DCA acts as a form of auto-pilot investing, allowing you to “set it and forget it.” Investing the same dollar amount every month is a straightforward strategy, and technology makes it easy to practice DCA as well as other types of automated investing. Though it’s always wise to review the performance of investments at regular intervals, with DCA, you don’t have to always keep your eye on different investments or even market volatility. Just stick to the plan.
You also don’t have to be wealthy in order to use the dollar cost averaging method. You can start small, but all the while, you will be contributing to and potentially growing an investment portfolio.
Dollar Cost Averaging Disadvantages
There are some drawbacks to dollar cost averaging. In some cases, investing a lump sum may net you a higher return over time. Although DCA may work well for managing volatility’s impact, over the long-term the market has historically trended upward, as average market return data shows. The average return of the S&P 500 over approximately the past seven decades is about 10% annually, or 6% to 7% when adjusted for inflation.
Investing your money sooner in a diversified portfolio means it has more time to potentially compound and grow. Past performance is no guarantee of future results, but the market’s historical performance is something to bear in mind.
When you use any kind of “set it and forget it” strategy, you run the risk of missing out on certain market opportunities. You can also miss out on any red flags. Although the upside of dollar cost averaging is its consistency, the potential downside is that you may be less aware if there are new opportunities — or heightened risk.
In addition, if the price of the asset keeps rising, you may end up buying fewer shares than you would have if you’d purchase it at the lower price with a lump sum.
Last, dollar cost averaging doesn’t solve the problem of rebalancing a portfolio — which any investors might consider doing regularly to ensure their portfolio aligns with their risk tolerance.
When to Use Dollar Cost Averaging
Dollar-cost averaging is typically best for an investor who is able to invest a consistent amount over time in a diversified portfolio.
• Small and steady approach: Many people assume they need large sums of money to invest successfully, but dollar-cost averaging lets investors put in small, consistent amounts over time and still have the potential to benefit from long-term market growth.
• Purchasing mutual funds: Mutual funds allow you to purchase a share that represents a very small allocation of the underlying investment portfolio. This means that you can diversify with much smaller dollar amounts than if you purchased the securities on your own.
• Investing in ETFs (exchange-traded funds): Similar to mutual funds, ETFs provide an opportunity to diversify with smaller dollar amounts. Additionally, ETFs are available to trade throughout the day, generally have low expenses, no investment minimums, and may offer greater tax-efficiency.
Comparing Dollar Cost Averaging vs. Lump-Sum Investing
Both dollar cost averaging and lump sum investing have pros and cons. To help decide which option is best for your long-term planning, consider your investment strategy and tolerance for risk.
New and experienced investors alike could potentially benefit from a dollar cost averaging strategy when investing in a diversified portfolio that experiences natural shorter-term volatility, while hopefully rising over time. A DCA investor may end up paying a lower price per share over the course of an investment.
Also, if market volatility makes you anxious and stresses you out, DCA could allow you to purchase assets and participate in the market in a small and consistent way, whether using a robo account or a self-directed investment account. This approach can be especially appealing for bear market investing, helping you feel more comfortable while avoiding the risk of investing a large sum before a market downturn.
However, you may alternatively consider lump-sum investing if you have the funds available and can stomach some market ups and downs. Lump sum investing may give you a higher net reward over time, assuming your investment rises long-term. This is because the entire investment would have more time to potentially compound and grow than if the same amount were invested gradually over a longer time period. Depending on the brokerage you use, you may also reduce potential trading fees compared to DCA investing.
Keep in mind that the price you pay for the lump sum investment could potentially be higher (or lower) than if you used a DCA strategy since it’s extremely challenging to try to time the market.
Consider all the pros and cons carefully to decide which strategy makes the most sense for you.
The Takeaway
Dollar-cost averaging is a straightforward strategy that may help reduce the impact of market volatility on your portfolio over time and keep emotional impulses from driving your buying or selling decisions. As a result, dollar cost averaging might help you stay in the market, even when it’s fluctuating, with the potential result that you could buy more when prices are low and less when prices are high. Overall, you may end up paying less on average.
But dollar cost averaging isn’t an excuse for literally “setting and forgetting” your portfolio. It’s still important to check on your investments in case there are any new opportunities or bona fide laggards. And once every 6 to 12 months, you may want to rebalance your portfolio to help stay on track to meet your financial goals.
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FAQ
Is dollar cost averaging a good idea?
Dollar cost averaging may be a good strategy for some investors to employ, particularly beginner investors or those with a low tolerance for risk. That’s because it allows an investor to regularly participate in the market by taking a small and steady approach, it’s automatic and eliminates the need to try to “time the market,” and it helps take the emotion out of investing, which can prevent panic buying and selling.
But it’s important to consider the downsides of DCA, too. For example, lump sum investing may result in a higher return than dollar cost averaging over time.
When is the best time to do dollar cost averaging?
There isn’t necessarily a best time to use a dollar cost averaging strategy, but it can be a useful technique for those who want to consistently invest without spending a lot of time and effort on it.
How often should you do dollar cost averaging?
When using a dollar cost averaging strategy, investors can choose a cadence that is best suited to their overall financial goals. For some, it may involve biweekly investments; for others, it may involve monthly investments. Think about your financial goals and then choose an investment interval that makes sense.
Where is dollar cost averaging most commonly done?
Dollar cost averaging is a strategy commonly used in retirement plans, such as 401(k)s, in which money is automatically deducted from your paycheck and invested in assets you’ve selected. However, individual investors can use dollar cost averaging any time in their own individual investment accounts, such as a brokerage account.
What are the risks of dollar cost averaging?
The risks of dollar cost averaging may include a potentially lower return compared to lump sum investing since the latter essentially puts more money into the market sooner, giving it a longer runway to potentially grow should the investment rise over time. Overall, with dollar cost averaging, you may also be less aware of certain market opportunities or potential risks that could incur losses.
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Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Dollar Cost Averaging (DCA): Dollar Cost Averaging (DCA) is an investment strategy where you regularly invest a fixed amount of money regardless of market conditions. This approach aims to reduce the impact of market volatility and lower your average cost per share over time. DCA does not guarantee a profit or protect against losses in declining markets. Investors should consider their financial goals and risk tolerance before using this strategy, understanding that past performance is not indicative of future results. Consult with a financial advisor to determine if DCA is appropriate for your individual circumstances.
Mutual Funds (MFs): Investors should read and carefully consider the information contained in the prospectus, which contains the Mutual Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or SoFi's customer service at: 1.855.456.7634. Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risks. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may have tax implications.
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Investment Risk: Diversification can help reduce some investment risk, but cannot guarantee profit nor fully protect in a down market.
S&P 500 Index: The S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an investment product, but a measure of U.S. equity performance. Historical performance of the S&P 500 Index does not guarantee similar results in the future. The historical return of the S&P 500 Index shown does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns. Options involve substantial risk of loss and the possibility an investor may lose the entire amount invested. Before starting options trading, investors should be familiar with the Characteristics and Risks of Standardized Options . TTax implications with options should be considered. Consult your tax advisor to understand any impacts to your taxes.
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