Dollar-Cost Averaging DCA: Definition, Calculation & How To Invest

how to dollar cost average

If the investor had spent the entire $5,000 at once at any time during this period, the total profit might be higher or lower. But by staggering the purchases, the risk of the investment has been greatly reduced. Since you’re buying more shares when the cost is low, you’re reducing your average cost per share over time. By contrast, had all $500 been invested in Month 1, the average cost per share would have been $5 for a total of 100 shares. It’s important to note that dollar-cost averaging works well as a method of buying an investment over a specific period of time when the price fluctuates up and down. If the price rises continuously, those using dollar-cost averaging end up buying fewer shares.

How Often Should You Invest With Dollar-Cost Averaging?

Dollar-cost averaging is the process of spreading out an investment purchase by investing equal dollar amounts at regular intervals. Instead of buying a stock or fund all at once, dollar-cost averaging involves portioning the purchase out over time. You can suspend the investments if you need to, though the point here is to keep investing regularly, regardless of stock prices and market anxieties.

The market rises over time

Just be aware of brokerage fees and your personal risk tolerance to help guide your investment decisions. As always, you can talk to a financial professional to find the best option for you. Dollar-cost averaging is a good strategy for investors who may not have tons of cash to invest right away as well as for people who don’t want to concern themselves with the ups and downs of the market. Instead of focusing on the ins and outs of “timing the market,” or making predictions on price movements, dollar-cost averaging is about consistently putting money into the market despite any gains or volatility. Let’s assume that $10,000 is split equally among four purchases at prices of $50, $40, $30 and $25 over the course of a year. Those four $2,500 purchases will buy 295.8 shares, a substantial increase over the lump-sum purchase.

Dollar-Cost Averaging vs. Lump-Sum Investing

If you have a workplace retirement plan, like a 401(k), you’re probably already using dollar cost averaging by default for at least some of your investing. A prime example of long-term dollar-cost averaging is its use in 401(k) plans, in which employees invest regularly regardless of the price of the investment. In effect, this strategy eliminates the effort required to attempt to time the market to buy at the best prices. Even experienced investors who try to time the market to buy at the most opportune moments can come up short. What you’re about to see are particular examples of how investing using Dollar-Cost Averaging would have turned out in several different assets.

  1. Dollar-cost averaging is one of the most popular ways to invest and build wealth for the long term.
  2. This is the one scenario where dollar-cost averaging appears weak, at least in the short term.
  3. Dollar-cost averaging is one of the best strategies for beginning investors looking to trade ETFs.
  4. Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price.

So the payoff profile looks nearly identical to the first scenario, and you’re not much better or worse off. With dollar-cost averaging, you actually have an overall gain at $40 per share of ABCD stock, below where you first started buying the stock. Because you own more shares than in a lump-sum purchase, your investment grows more quickly as the stock’s price goes up, with your total profit at an $80 sale price more than doubled. First, let’s see what happens with a $10,000 lump-sum purchase of ABCD stock at $50, netting 200 shares. Let’s assume the stock reaches the following prices when you want to sell. The column on the right shows the gross profit or loss on each trade.

how to dollar cost average

This way, you don’t have to wait until you have a larger amount saved up to benefit from market growth. Also, if you are implementing a dollar-cost averaging approach, those funds in waiting are typically held in cash or cash equivalents that earn very low rates of return. Check out the table below to see how this strategy might play out using varying stock prices.

Let’s say you made a lump sum investment and invested all $6,000 in $25 shares in January. Over the course of four months, your investments would face the markets ups and downs throughout the year, landing you with an even $6,000. Decide which investment you’re interested in achieving dollar-cost averaging for, such as a mutual fund, ETF, or stock. Many brokerage firms and investment companies allow investors to choose multiple investments for periodic, systematic investing.

By investing a fixed amount regularly, you will end up buying more shares when the price is lower than when it is higher. From regular brokerage accounts to retirement accounts like 401(k)s, IRAs, and more, dollar-cost averaging is one of the most widespread ways for investors to break into the market. It’s a more gradual approach that helps investors guard against never buying too much at too high of a price. If you’re looking for a way to get into the market for the long term, dollar-cost averaging may be the right approach for you. In periods of economic growth and market gains, lump sum investing has generally outperformed dollar-cost averaging.

“It’s probably the most effective strategy for all investors at all levels. It’s one of the best ways to set it and forget it but you do want to pay attention to what you’re investing in,” says LaFleur. Then you can instruct your brokerage direct and indirect bills to set up a plan to buy automatically at regular intervals. Even if your brokerage account doesn’t offer an automatic trading plan, you can set up your own purchases on a fixed schedule — say, the first Monday of the month.

A DCA strategy can reduce the volatility of an initial investment because the investor makes purchases over regular intervals, as opposed to all at once. Dollar-cost averaging can be achieved via the setup of an automated investment program, or through an investor’s own judgments of when to making follow-up investments. In addition, mutual funds and even individual stocks don’t, as a general rule, change in value drastically from month to month. You have to keep your investment going through bad and good times to see the real value of dollar-cost averaging.

The level of risk is entirely up to you and your financial analysis capabilities. System response and account access times may vary due to a variety of factors, including trading volumes, market conditions, system performance, and other factors. That is the big question when deciding whether to invest all at once in one lump sum, or over time using dollar-cost averaging. Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

It’s worth noting that dollar-cost averaging doesn’t always result in a lower average cost. If the price of the security rises following the first purchase, and remains at that higher price, the average cost realized will be higher. Another thing to consider is that through dollar-cost averaging you could end up dealing with more brokerage fees which could take a chunk out of your nest egg. Be sure to research fees and costs as part of your investment planning. As noted above, dollar-cost averaging may offer less in the way of returns than lump-sum investing in some instances. Additionally, when prices are high you may get less bang for your buck.

The rest is very simple, follow your strategy and don’t look back, only time tells if you’re right or wrong. By adopting a passive approach, you will not respond to fluctuations in the market, good or bad. As the investment environment changes, you might get new information about an investment that makes you rethink your approach. If you have a 401(k) retirement plan, you’re already using the dollar-cost averaging strategy.

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