In this article we’ll cover:

  • What is Dollar Cost Averaging (DCA)

  • Benefits of DCA compared to other purchasing methods

  • How do you set up an automatic DCA?

  • If you have a lump sum, like $10k, how long should it take for you to fully enter the market? Should you put it all in at once?

What is Dollar-Cost Averaging?

Dollar-Cost Averaging (DCA) is an investment strategy in which the investor systematically invests equal amounts of money into a security regardless of the price of the asset. Generally, DCA is used with ETFs and mutual funds, but it is a strategy that can be employed with any kind of security. This means that you would invest the same dollar amount whether or not you believe the security/market is up or down. By utilizing DCA, it can help an investor’s efforts of trying to invest regularly and can help them navigate unpredictable market conditions.

The idea behind DCA is that it reduces the average cost per share and reduces the volatility of an investment portfolio. This eliminates the effort of trying to time the market, which is extremely difficult even for the most seasoned investors. DCA assumes that the price of the investment will increase in the long run, which is why it reduces the average cost per share. Furthermore, by investing the same amount no matter the market conditions, you bypass some of the volatility of the market.

Now, it is worth noting that DCA does not guarantee returns all the time. If the market rises steadily, then DCA will buy less and less shares, since you invest on a money basis and not a share basis. Also, if the market declines steadily, an investor using DCA would keep buying when it would be better off being on the sideline. That being said, it is difficult to tell when a market will continue to rise/decline, so DCA tends to be the best investing strategy for most individuals.

Dollar-Cost Averaging vs. Value Averaging

Value averaging is another investment strategy that is generally used for less volatile securities. An investor employing value averaging would try to invest more when share prices fall and invest less when they rise. The following table shows some of the pros and cons of each strategy.

How to Automate Dollar-Cost Averaging

The first step is to set up automatic payments to your brokerage account from your bank account. Most banking mobile apps have a streamlined process of accomplishing this, but, if you are having trouble, you should consult with your bank to see how it is done. Once the money is in your brokerage account, you can take advantage of the plans that many brokerages have set up. One example of such a plan is the Automatic Investment Plan from Merrill Edge. These types of plans will practically automate the whole process for you. If your brokerage does not have such a plan in place, you should reach out to them and see what their process is for automating investments. Typically, most brokerages have an option for setting up automated purchases on a certain security somewhere on the main page or info page of a security.

Dollar-Cost Averaging Example

Let’s say you have $10,000 you would like to invest. If you were to put it all in at once, you had better have a high risk tolerance. The market is an unpredictable beast, so, if it does not end up moving in the right direction, you will quickly lose a good chunk of your hard earned money.

If you decide that DCA is the correct investment strategy for you, then your next natural question would be how much and when do I invest? It is generally advisable to base these numbers based on how you anticipate investing in the future. For example, if you plan on investing $1000 every two weeks, you could start your DCA strategy with similar numbers. In this example, assuming you wanted to invest $1000 every two weeks, you could begin at investing $1500 every two weeks, and then, once you invested the $10,000 you wanted to invest, begin investing at a rate of $1000 every two weeks. If you would like to get your money into the market sooner, then you should make your initial investments larger. The quicker you want your money in the market, the larger your initial investments should be. Remember, though, the larger initial investments you make, the more risk you will take on. It is always important to remember how much risk you are putting yourself into when investing, and employing DCA as your investing strategy is no different.