Dollar-Cost Averaging

When you use the investment strategy known as dollar-cost averaging, you end up buying a greater number of shares when the price is low and fewer when the price is high, so the average price you pay is lower than the average price of the stock during the same time period.

Dollar-Cost Averaging

The only trick is to invest the same amount regularly into the same investments. If you invest $50 per week in a particular stock, you'll end up buying 10 shares when it's at $5 per share, and you'll buy 5 when the price is at $10. In just those two buys, the price was at $10 and $5, so the average price was $7.50 per share, but you ended up with 15 shares and paid $100, so you paid only $6.67 per share. You paid over 10% less just by using the absolute minumum dollar-cost averaging strategy of splitting a single purchase into two.

It would've been best to have bought all your shares when the price was at $5 per share, but doing that requires timing the market, which many experts consider impossible. They say you can't know the best times to buy or sell, but we try anyway. DCA eliminates much of the need for perfect timing.

This strategy is better than buying a constant number of stocks regularly. You end up with more stocks for your money by buying more when the price is low and less when the price is high. If you have a 401k, you might already be using DCA without your realizing.

Dollar-cost averaging is not magic and will never give you a better price than you could get by being lucky or successful at timing the market. And if the price ranges between 50 and 60, dollar-cost averaging will never give you a price lower than 50.

Successfully timing the market can require great skill, while dollar-cost average requires none. DCA is like insurance against buying at the wrong time, but it costs nothing except the time of extra transactions.

The strategy of dollar-cost averaging is helpful for volatile investments, but not for reliable, steady-growth investments, where it is best to invest it all up front if possible instead of gradually over time. This would also imply that if you have savings or inheritance or other wealth to invest upfront, it's best to put that in the reliable steady-growth investments, then gradually transfer part of that and your regular income into more volatile investments over time using dollar-cost averaging.

We can use dollar-cost averaging in many different ways. Your time interval for buying might be monthly, weekly, daily, or even hourly. Volatility exists at all time scales, so there's no single timeframe that dollar-cost averaging should only be used at. Use it wherever there is volatility.

In fact, you might even be hoping for more volatility when you use DCA, because it can be disappointing when the price is almost exactly the same between purchases.

You can even use DCA even when you choose to invest upfront or time the market. Just choose a shorter time scale. Instead of spreading out purchases throughout a year, you could spread them out over a day or two.

Dollar-cost averaging gives you a lower price, so only use it for buying. Using DCA for selling is a bad strategy, so we must be careful not to forget and get it backward. Similarly, you should try to avoid ever selling stocks by dollar amount. Never say you want to sell $5000 worth of a stock, for example. Doing so is the same as dollar-cost averaging during selling, causing a lower average price per share. Maybe you need $5000, so use that figure as a base, but sell only by number of shares and consider modifying that value based on something else, like performance or expected performance.

Suppose you own $4000 of a stock and you want to transfer the money into something else, so you decide to sell $1000 per week. But this is the same as using dollar-cost averaging for selling instead of buying, which is stupid. Instead of selling the same value of shares at each interval, you should sell the same quantity of shares to avoid making your average selling price lower.

I've put together a fun little toy web app for you that demonstrates dollar-cost averaging, allowing you to adjust various details and see how much you might make in different conditions.

This page is intended as educational and informative and is not to be taken as personalized financial advice. Strong efforts are made to ensure these documents are correct, but there could be mistakes, especially when first uploaded. Please verify important facts before making investing decisions.