Investing

What Is Dollar Cost Averaging?

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Dollar-cost averaging is a strategy for investing where you invest about the same amount at regular intervals, regardless of market performance.

This strategy lessens your chances of buying when the price per share is too high, lowering your investment’s purchase price. We dive into how dollar-cost averaging works and when it may make sense for your investments.

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What is dollar cost averaging?

Dollar cost averaging (DCA) is investing regularly no matter what’s happening in the market. By doing so, you’ll “average out” the price you pay for your investments. With this strategy, the lowest and highest prices you pay for shares of the same investment meet somewhere in the middle, which lowers your overall per-share cost.

Dollar cost averaging is a common strategy, especially if you have retirement accounts. For example, say you have a 401(k) through your employer and make regular contributions with every paycheck. That means you’re already on the dollar cost averaging train.

How does dollar-cost averaging work?

Dollar-cost averaging splits up the cash you have to invest over a long period of time. So instead of making one large lump sum investment, you’ll make several smaller, regular purchases of the same dollar amount.

Let’s see how that works in the real world.

Say you have $500 to invest in a stock. With DCA, you’ll buy $100 worth of shares every month for five months. Here’s how that looks:

Dollar-Cost Averaging Example
TimingAmount investedShare priceTotal shares purchased
Month 1$100$250
Month 2$100$520
Month 3$100$425
Month 4$100$520
Month 5$100$250
Total invested: $500Total shares owned: 165

Since you’re investing the same amount each month, you’re buying fewer shares when the cost is high and more when the cost is low. So the average price you pay per share is lower, too.

Dollar-cost averaging pros and cons

Pros

  • Steady investments. Some people make their investment contributions after a long list of other needs are met, like paying bills and paying down debt. With DCA, you add money to your investments just like any other bill.
  • Minimizes risk. Investing the same amount every month means you don’t have to watch the market constantly to see when to jump in. DCA lets you keep investing regularly but without pricing concerns.
  • Removes emotion. The stock market’s price swings are enough to stress any investor. But with dollar cost averaging, you don’t have to watch the market at all. Instead, your buys go on autopilot, taking emotion out of the equation.

Cons

  • Negative impact on returns. Even though you’re buying less when prices are high, you’re also not investing more when prices are low. You’re losing out on not maximizing profits by establishing a lower cost basis for investments.
  • Increased trading fees. If you’re constantly buying stock, the per-trade commissions could add up depending on your brokerage. If commission costs are a concern, look for a brokerage with commission-fee trades.
  • Not ideal for all investors: DCA might work well if you have long-term retirement plans like a 401(k) or IRA. But if you’re a more active trader, like a day trader, lump-sum investing might make more sense since you’re only holding investments for the short-term.

Lump sum vs. dollar cost averaging

Dollar cost averaging is an excellent strategy for long-term investing. It minimizes your overall risk, removes emotion and continuously keeps you investing. However, it might not be best if you’re looking for a quick cash out.

Lump-sum investing gives you a chance to invest in stocks at a low price point, which is good if you have a solid working knowledge of the stock market. However, if you opt for a lump-sum investing approach, you might put off investing until you’ve saved a certain amount, which could translate to missing that low price. You also risk missing potential earnings every day you’re not invested.

But even though DCA and lump-sum investing tend to produce similar returns during stable markets, the example above proves that even $1 to $2 per share makes a difference. 

Imagine taking your $500 and investing it all at once, buying shares at $5 each. You’d have 100 shares, not 165. That’s a loss of 65 shares which can each appreciate and add to your wealth.

While there’s no clear-cut answer for all investors when weighing lump sum vs. dollar cost averaging, your best choice will generally be the one that:

  • Makes the most sense for how much you have to invest.
  • Whether you can commit to making regular investments of the same amount.

How to dollar cost average when investing

There’s not much to learning how to dollar cost average. It’s a straightforward three-step process that you can start today.

Step 1: Decide the amount and frequency

If you’ve received a bonus, raise or inheritance, you can set aside a certain monthly amount for your investments. Then, put your extra cash in a high-yield savings account and set up a scheduled payment to auto-deduct from that account. For some people, contributing every paycheck might be best.

Auto-deductions let you set the amount and date to be consistent every month. Automation removes the emotion tied to contributing to your investments. You’re setting it and forgetting it.

Step 2: Decide where to invest

You can set up contributions through your 401(k), which your employer can help you manage. You can also open an IRA or taxable brokerage account with an online broker or robo-advisor.

As you compare options when opening an account outside your employer’s plan, compare account features side-by-side. From account fees and commissions to any changes you might incur when you want to withdraw money from your account, a little research can prevent being caught off guard down the line.

Step 3: Invest at regular intervals

After opening your account, link your bank and set up automatic contributions to your investment account. You can increase or decrease your contributions based on your immediate needs. The best option is to stay as regular as possible to make investing a habit.

The bottom line

Dollar cost averaging is a valuable strategy, especially if you’re investing for the long term. By making regular investments of the same dollar amount, you’re lowering your average price per share while building your wealth.

And if you want some help crafting the perfect financial plan to set on autopilot, consider talking to a financial advisor. They cost less than you think, and we can even help you choose one with our no-cost guide to finding a financial advisor.

Frequently asked questions

Dollar cost averaging is investing the same sum of money in a single asset, like a stock or ETF, at regular intervals over a period of time. The price you pay over time “averages out,” with your lower-cost buys bringing down the cost of those made at higher prices.

Dollar cost averaging works best for those investing for the long term who want to put their savings on autopilot. Lump-sum investing is likely a more suitable strategy for those investing for the short-term, like day traders.

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