Dollar Cost Averaging

What Is Dollar Cost Averaging?

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Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

Key Takeaways

Dollar-cost averaging is the practice of systematically investing equal amounts of money at regular intervals, regardless of the price of a security.
Dollar-cost averaging can reduce the overall impact of price volatility and lower the average cost per share.
By buying regularly in up and down markets, investors buy more shares at lower prices and fewer shares at higher prices.
Dollar-cost averaging aims to prevent a poorly timed lump sum investment at a potentially higher price.
Beginning and long-time investors can both benefit from dollar-cost averaging.

How Dollar-Cost Averaging Works

Dollar-cost averaging is a simple tool that an investor can use to build savings and wealth over the long term. It is also a way for an investor to ignore short-term volatility in the broader markets.

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.

With a 401(k) plan, employees can choose the amount they wish to contribute as well as those investments offered by the plan in which to invest. Then, investments are made automatically every pay period. Depending on the markets, employees might see a larger or smaller number securities added to their accounts.

Dollar-cost averaging can also be used outside of 401(k) plans. For instance, investors can use it to make regular purchases of mutual or index funds, whether in another tax-advantaged account such as a traditional IRA or a taxable brokerage account.

Dollar-cost averaging is one of the best strategies for beginning investors looking to trade ETFs. Additionally, many dividend reinvestment plans allow investors to dollar-cost average by making purchases regularly.

Let's say you invest $100 every month. When the market is up, your $100 will buy fewer shares, but when the market is down, your money will buy more. Over time, this strategy could lower your average cost per share—compared to what you would have paid if you'd bought all your shares at once when they were more expensive than the average.

WITH DOLLAR COST AVERAGING

Timing
Amount
Share price
Share purchased
Month 1
$100
$5
20
Month 2
$100
$5
20
Month 3
$100
$2
50
Month 4
$100
$4
25
Month 5
$100
$5
20
Total invested:
Average cost/share:
Total shares purchased:
500
$3.70
135

The example is hypothetical and provided for illustrative purposes only.

As you can see above, dollar cost averaging enabled our hypothetical investor to take advantage of a price decline in Month 3, significantly reducing the average cost per share. Despite paying $4 or more per share in four out of the five months, the average cost per share came out to $3.70, and the investor was able to purchase a total of 135 shares.
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.

WITHOUT DOLLAR COST AVERAGING

Timing
Amount
Share price
Share purchased
Month 1
$500
$5
100
Month 2
$0
$5
0
Month 3
$0
$2
0
Month 4
$0
$4
0
Month 5
$0
$5
0
Total invested:
Average cost/share:
Total shares purchased:
500
$5
100

The example is hypothetical and provided for illustrative purposes only.

In a perfect world, the investor would have placed all the money in Month 3 and walked away with 250 shares. However, there was no way of knowing ahead of time that this was the best time to buy, which is why dollar cost averaging is so valuable. By investing frequently and regularly over a long period of time, you're less likely to miss out on those buying opportunities.

Is Dollar Cost Averaging Right For You?

Dollar-cost averaging is beneficial because it can reduce investor anxiety, help avoid trying to time the market, and can provide a predictable, regimented way to continuously grow your nest egg. If that's of interest to you, there are a few simple steps to follow:

01

Decide how much money you want to invest

It could be a one-time windfall you want to put in the market or it could be a set amount you intend to contribute on a regular schedule indefinitely.
02

Decide how many periods you want to split the investment over

With trading commissions all but gone, it can be daily, weekly, monthly, or any interval you want.
03

Decide how many periods you want to split the investment over

Again, it could be a few times, or it could be the start of a permanent routine.
04

Decide the dollar amount invested at each interval

If it's a lump sum, divide the amount by the number of periods. If it is an indefinite investment plan, budget how much you can reliably afford.
05

Stick with the plan, no matter what markets do on a particular day or week

There is no one right way to invest. But if you're an investor looking to increase your net worth but worried you might be tempted to time the market, or you're dedicated to adding a little bit each month regardless of recent stock returns, dollar-cost averaging can be an effective way to build your portfolio.