What Is DCA? Dollar-Cost Averaging Meaning and Guide

Dollar-cost averaging (DCA) is an investment strategy of investing a fixed dollar amount in certain assets such as securities at regular intervals, regardless of market conditions. Rather than trying to time the market, DCA investing spreads purchases over time, which may help reduce the impact of volatility on an overall portfolio.

With DCA, an investor chooses the assets they want to buy and a fixed dollar amount to invest on a schedule, whether monthly, biweekly, or another interval, and then automates 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 of DCA investing to be aware of.

What Is Dollar-Cost Averaging (DCA)?

Dollar-cost averaging is an investment strategy that involves buying a fixed dollar amount of an investment on a regular basis, such as monthly.

The Meaning of DCA Investing

The goal of DCA investing is not to invest when prices are high or low, but rather to keep an investment steady and repeatable, and thereby avoid the temptation to time the market.

Because the same dollar amount is invested each time, an investor automatically buys 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 out of fear when prices drop and more out of optimism when prices rise. DCA may help to remove that impulse by making contributions automatic and consistent.

How Dollar Cost Averaging Works

The way dollar-cost averaging works is that an individual invests a fixed dollar amount in an investment at regular intervals, regardless of the investment’s price. It may be as simple as investing $5 in Fund A every other week, or something similar, no matter what’s going on in the market.

That way, the individual is investing the same amount whether the market goes up or down. For example, if they invest $100 in Fund A at $20 per share, they get 5 shares. The following month, say, the price has dropped to $10 per share, but they stay the course and invest $100 in Fund A — and they get 10 shares.

Over time, the average cost of their investments — the dollar amount they’ve paid — may end up being a little lower, which may benefit the overall value of their investment portfolio.

Cost Average Investing

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 DCA investing 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 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.

Example of Dollar-Cost Averaging

Here’s an example of how dollar-cost averaging might look in practice when buying shares of an exchanged-traded fund (ETF).

Investor A might decide to invest in ETFs and buy 20 shares of an 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 for the same ETF.

•   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.

Benefits and Disadvantages of DCA

Dollar-cost averaging has potential advantages, but it also comes with tradeoffs worth understanding.

Dollar-Cost Averaging Benefits

One key component of DCA investing is that it requires staying the course, regardless of volatility. It keeps investors from trying to time the market or — or from figuring out when to do stock trading online, for example. By investing the same amount of money every month, investors will buy more shares if the market is down and fewer shares if the market is up. With DCA, they’re not investing with their emotions, which may lead to impulsive choices.

DCA acts as a form of auto-pilot investing, allowing investors to “set it and forget it.” Investing the same dollar amount every month is a straightforward strategy, and technology typically makes it easy to practice DCA. Though it’s wise to review the performance of investments at regular intervals, with DCA, an investor doesn’t have to constantly keep their eye on different investments. It’s generally about sticking to the plan.

An individual also doesn’t have to be wealthy to use the dollar-cost averaging method. They can start small, but all the while, they will be contributing to and potentially building an investment portfolio.

Recommended: What Is Compound Interest?

Dollar-Cost Averaging Disadvantages

There are some drawbacks to dollar-cost averaging. In some cases, investing a lump sum may net a higher return than DCA over time. Although DCA may work well for managing volatility’s impact, over the long-term the market has historically trended upward, according to average market return data. 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 a single lump sum of money in a diversified portfolio means the entire amount may have more time to potentially grow vs. adding the same amount in increments over time. Past performance is no guarantee of future results, however, and there is always a risk of losing money.

When an investor uses any kind of “set it and forget it” strategy, they may miss out on certain market opportunities. They might also miss seeing any red flags. Although the upside of dollar-cost averaging is generally its consistency, the potential downside is that an investor may be less aware of new opportunities — or heightened risk.

In addition, if the price of the asset keeps rising, an individual may end up buying fewer shares than they would have if they’d purchase it at the lower price with a lump sum.

With the autopilot strategy of dollar-cost averaging, there’s the potential that an individual may not be looking at asset allocation or rebalancing their portfolio. Generally speaking, investors may want to consider rebalancing regularly to ensure their portfolio aligns with their risk tolerance.

When to Use Dollar Cost Averaging

Dollar-cost averaging could be a strategy worth considering for an investor who is able to invest a consistent amount over time in a diversified portfolio. Here’s why:

•   Small and steady approach: Some people may 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 in a robo or self-directed investment account.

•   Purchasing mutual funds: With mutual funds, individuals can purchase a share that represents a very small allocation of the underlying investment portfolio. This generally means an investor can diversify with much smaller dollar amounts than if they purchased the securities on their own.

•   Investing in ETFs: Similar to mutual funds, ETFs are a way for an investor to diversify with smaller dollar amounts. Additionally, ETFs generally have low expenses and may offer greater tax-efficiency than mutual funds.

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 their long-term planning, an investor should consider their investment strategy and tolerance for risk.

New and experienced investors alike may potentially benefit from a dollar-cost averaging strategy when investing in a diversified portfolio with, for instance, different types of stocks, as well as other types of assets that experience 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 an individual anxious and stresses them out, DCA may allow them to purchase assets and participate in the market in a small and consistent way. This approach could be especially appealing for bear market investing, helping an investor feel more comfortable while avoiding the risk of investing a large sum before a market downturn.

However, investors might alternatively consider lump-sum investing if they have the funds available and can stomach some market ups and downs. Lump-sum investing may give them a higher net reward over time, assuming their investment rises long-term. This is because the entire investment would have more time to potentially grow than if the same amount were invested gradually over a longer time period. Depending on the brokerage the investor uses, they may also reduce potential trading fees compared to DCA investing.

Those considering lump-sum investing vs. DCA should keep in mind that the price they pay for the lump-sum investment could potentially be higher (or lower) than if they 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.

How to Start Dollar Averaging Stocks

Dollar-cost averaging stocks means investing a fixed amount of money in securities at regularly scheduled intervals. To get started, an investor typically decides how much they can comfortably afford to invest regularly, and then determines how often they want to invest, such as twice a month or monthly.

Then, the investor can select the assets they want to invest in. They might research and choose certain individual stocks, or they could choose an index fund that tracks a stock market index like the S&P 500. Funds generally offer portfolio diversification, which may help manage risk, though diversification doesn’t guarantee profit or fully protect a portfolio from potential from losses.

The next step is to open a brokerage account and set up automatic transfers. An investor can have money regularly deposited into the account, and also set up automatic “buy orders” for their investments. That way, their chosen amount of money will be invested automatically over time on the schedule chosen by them. It’s generally wise to review a portfolio once or twice a year to make sure the investments and the DCA investing strategy still align with the investor’s goals.

The Takeaway

Dollar-cost averaging is a straightforward strategy that may help reduce the impact of market volatility on a portfolio over time and keep emotional impulses from driving an investor’s buying or selling decisions. As a result, an individual using dollar-cost averaging might stay in the market, even when it’s fluctuating, with the potential result that they could buy more when prices are low and less when prices are high. Overall, they may end up paying less on average.

But dollar-cost averaging isn’t an excuse for literally “setting and forgetting” a portfolio. It’s still important to check on investments. And once every 6 to 12 months, an investor may want to rebalance their portfolio to help stay on track to meet their 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, such as beginner investors or those with a low tolerance for risk. DCA could provide them with a way to regularly participate in the market by taking a small and steady approach. Additionally, it’s automatic, eliminating the need to try to “time the market,” and it typically helps take the emotion out of investing, which may help prevent panic buying and selling.

But it’s important to consider the downsides of DCA. 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 could be a useful technique for those who want to consistently invest without spending a lot of time and effort on it. That said, it’s always advisable to review an investment portfolio regularly for performance and potential rebalancing.

How often should you do dollar-cost averaging?

When using a dollar-cost averaging strategy, investors can choose a cadence that is 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.

Does cost averaging work for all asset classes?

No. Dollar-cost averaging generally doesn’t work well for short-term investing or illiquid assets (those that can’t be quickly sold or converted to cash) because it doesn’t protect against drops in the market. DCA typically works better for long-term assets, like broad market index funds and ETFs, because it takes the emotion out of investing and may lower the average cost per share over time.

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 a lump-sum strategy 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, an investor may also be less aware of certain market opportunities or potential risks that might incur losses.

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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.
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