What is dollar-cost averaging?

Numerous strategies promise to optimize returns and minimize risks. One particularly favored by those new to investing is dollar-cost averaging (DCA). This method offers a systematic approach to investing, making it an ideal choice for investors who are just starting to navigate the complexities of financial markets. Chances are, you may presently be using DCA already without realizing it. Contributions to retirement accounts, such as 401(k)s, typically involve dollar-cost averaging, given the periodic investment frequency.

Dollar-cost averaging is a straightforward investment strategy where you invest a fixed amount of money into a particular investment at regular intervals—regardless of the investment's price. For example, instead of investing a lump sum in a stock or fund, you invest smaller amounts periodically. This could be monthly, quarterly, or even weekly, investing roughly the same amount at each interval.

The strategy is like wading into a swimming pool rather than diving in headfirst. It allows investors to mitigate risk over time, purchasing more shares when prices are low and fewer when prices are high. This can be particularly advantageous in volatile markets, where it's challenging to predict short-term gains and losses.

Imagine you have $1,200 to invest. You could choose to invest it all at once, putting your entire investment at risk in hopes you timed the market right, or you could use dollar-cost averaging.

By choosing the latter, you might decide to invest $100 every month for 12 months. The number of shares you purchase each month will vary based on the current market price. For instance, if the share price is $17, your $100 will buy you 5.9 shares. If the price drops to $12, the same amount will buy you approximately 8.3 shares, and so on.

This method reduces the risk of investing a large amount in a single market high, potentially leading to losses at even the slightest market downturn.

Benefits of dollar-cost averaging

1. Simplicity—Dollar-cost averaging takes just minutes to set up through complimentary automatic investing services offered by many financial institutions.
2. Suitability for long-term goals—This style of investing may be a good fit for building savings and wealth over the long term, as gradual investing helps reduce the impact of day-to-day price fluctuations.
3. Encourages action—By investing regularly, DCA helps curb the temptation to overreact to market volatility, which can lead to poor investment decisions.
4. Accounts for volatility—Because investments are made over time at various prices per share, the strategy is particularly suited to lessen the effects of market fluctuations on your overall purchase.

Cash drag

While dollar-cost averaging has its advantages, it also has drawbacks. In a consistently rising market, DCA may lead to missed opportunities as not all capital is invested from the start. This can result in what's known as "cash drag," where uninvested cash fails to earn returns. Additionally, greater frequency of additional investments might mean more transaction fees, although this depends on the terms set by your investment platform.

Dollar-cost averaging vs. lump-sum investing

The debate between investing all at once (lump-sum investing) and spreading out investments through DCA is ongoing.

• Lump-sum investing might be suitable for those who believe the market will rise steadily over time. This approach can be riskier, however, as it involves making one large investment at a single point in time, which could coincide with a market high. Lump-sum investing can get you into the market faster, but it could also expose you to more risk.
• Conversely, DCA offers a more conservative approach. For those concerned about short-term market drops after investing a large sum, DCA offers a way to invest cautiously and still participate in potential long-term gains. While DCA could help protect you against market volatility, it could also limit your upside in a bull market.

Dollar-cost averaging offers a balanced approach to entering the markets. It alleviates some of the stresses associated with timing the market and can lead to a more disciplined investment strategy. While it may not always outperform lump-sum investing in a bull market, its benefits in risk management and ease of use make it a worthy consideration for those looking to build their investment portfolio gradually.

CRC# 4091975 06/2025