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Dollar-Cost Averaging: A Good or Bad Strategy?

A time-honored strategy for many people in the investment world. But maybe you aren’t super familiar with its benefits.

By FlexInvestPublished 3 years ago 4 min read

Dollar-cost averaging (DCA) is an investment technique that involves buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price.

Depending on an individual’s investment objectives and risk profile, regular contributions can be invested in a mixed portfolio of mutual funds, exchange-traded funds (ETFs), or even individual stocks.

However, if you go with the latter option, keep in mind that that it takes at least 10-15 stocks to have a properly diversified portfolio. For this reason, DCA may not always be the most practical. But, you can always invest in a portfolio or mutual fund on a set schedule and still comply with DCA principles.

How does Dollar-Cost Averaging works?

With this technique, you make contributions at the same intervals, meaning the number of shares that your money can buy will vary. As share prices decline, the fixed amount buys a higher number of shares. Conversely, when prices increase, the fixed amount buys fewer shares.

For example, let’s assume you want to invest $5,000 over a period of 5 months ($1,000 each month) into Portfolio X. The share price of Portfolio X at the beginning of each month could vary as follows:

  • Month 1: $20
  • Month 2: $15
  • Month 3: $11
  • Month 4: $18
  • Month 5: $22

On the first of each month, you buy as many shares with $1,000 as possible. In this example, the number of shares purchased each month would be:

  • Month 1: $1,000 / $20 = 50 shares
  • Month 2: $1,000 / $15 = 66.67 shares
  • Month 3: $1,000 / $11 = 90.91 shares
  • Month 4: $1,000 / $18 = 55.55 shares
  • Month 5: $1,000 / $22 = 45.45 shares

Though the number of shares bought per month varied, you invested $1,000 each month for five months, summing $5,000 in initial investment. In this case, the total number of shares you own is 308.58. And if the price of the shares is $23 after these five months, an original investment of $5,000 has turned into $7,097.34.

If the investor had spent the entire $5,000 on one of these days instead of spreading the investment across five months, the total profitability of the position could be higher or lower than $7,097.34, depending on the month chosen for the investment. However, no one can time the market.

That’s why DCA is often considered a safe strategy to ensure an average price per share that is favorable overall. By buying a fixed dollar amount of a certain investment on a regular schedule, you're accumulating assets rather than spinning your wheels trying to perfectly time the market.

The benefits

  • DCA can be especially powerful in a bear market, allowing you to ‘buy the dips,’ or purchase stock when its price is low. When this happens, most investors are too afraid to buy so they sell fearfully. This technique allows you to score a good price and set yourself up for strong long-term gains. Remember, market movements are normal, and with dollar-cost averaging a bear market can be a great long-term opportunity, rather than a threat.
  • There's no real emotion tied to this method of buys assets, meaning no impulse decisions based on price swings.
  • DCA offers some degree of ‘protection’ in the long-term, should an asset have a rough couple of weeks. And it even helps you invest for a low price and capitalize your gains once the prices are back up.
  • It simplifies investing; once you’ve made your choice, you don’t have to worry about deciding if you have to invest again or how much should you deposit. Moreover, you’re less sensitive to market information or the media hype.

Some downsides

  • While DCA might help you avoid some bad timing, using a DCA strategy also means you can miss out on some great opportunities. This might be particularly frustrating for investors who carefully watch the prices of the securities that interest them. But, if you’re investing with a long-term perspective, without trying to time the market, you shouldn’t be too concerned about short-term volatility.
  • DCA is not a particularly valuable short-term strategy. Let’s say you purchase 10 shares of a company over the course of a month. While the purchase price of the shares is not likely to be identical for each transaction, it is probable that these differences will be minimal over such a short time frame. On the other hand, if you invest the same amount over the course of 5 years or more, the price of a given security is likely to change significantly. You’ll probably invest in both bull and bear markets. DCA will help to ensure that your average cost per share represents both the premiums of a bull market and the discounts of a bear market.
  • DCA does not guarantee that an investor won't lose money on investments. Rather, it is meant to allow investment over time instead of investment as a lump sum.
  • Some argue that buying more frequently adds to trading costs. However, with more brokers moving to lower fees, investing regularly has become more affordable.

The takeaway

DCA is a reliable investment strategy, especially for those who tend to make emotional decisions based on market volatility. It sets you up for investing regularly to focus on the long-term. And to make sure you enjoy all of its benefits, try to implement it on diversified portfolios, ETFs, and mutual or index funds.

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