Takeaways
- Dollar-cost averaging is a long-term investing strategy.
- Dollar-cost averaging reduces pricing volatility and lowers the cost over time.
- Consistently investing at regular periods removes decision fatigue from investing.
- Dollar-cost averaging removes pricing risk and single purchase exposures.
- Investors, new and seasoned, can benefit from adopting dollar-cost averaging.
The best intuitional investors in the world have difficulty timing the market. Trying to figure out when the stock market will go up or down can be a poor investment strategy because investors either wait too long and never invest or get frustrated by short-term investment gains and losses.
Instead of trying to figure out market fluctuations, you should be focused on investing consistently over the long term, regardless of price. This investment strategy is called dollar-cost averaging.
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What Is Dollar-Cost Averaging?
Dollar-cost averaging is the process of purchasing shares of stock or a fund over a regular interval, regardless of the stock price, to reduce pricing risk from a single point in time purchase.
The advantage of adopting the dollar-cost averaging investment strategy is that it is easy to implement. You may already be adopting this strategy if you automate your investing or invest regularly in your employer-sponsored 401(k) plan.
Adopting the dollar-cost averaging philosophy of investing means that you will be investing in both bull and bear markets. When the stock market goes up, you will make purchases, and when the stock market goes down, you will continue to make purchases.
Using the dollar-cost averaging strategy can remove the anxiety from investing because you continuously deploy capital into the stock market. Do this regularly to ensure you are adopting the strategy.
Some investment vehicles, such as dividend reinvestment plans (DRIPs), will automatically reinvest your dividend distributions into stocks, increasing your investment even further. This automatic dividend reinvesting is done regularly in alignment with dividend payment schedules, deploying your dividend payments back into stock purchases.
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How to Start Dollar-Cost Averaging
With the infrastructure in place, implementing the dollar-cost averaging investment strategy can be great for investors saving for retirement or meeting other financial goals.
With an online brokerage account, you can begin using dollar-cost averaging immediately. Some brokerages allow you to set up automatic trading plans within your account which allows you to determine when and how much you want to invest in a particular stock, ETF, or mutual fund. Alternatively, you can do this manually by purchasing investments regularly, say the 1st and 15th of every month.
A great way to implement this strategy is if you have access to an employee-sponsored 401(k) program. With these programs, you can determine how much of each paycheck you want to allocate to your retirement account, say 15%, and then set it and forget it. Each paycheck’s pretax income will flow directly into your retirement account, purchasing investments regardless of price. If you do this for a year, you will make regular contributions, buy the stock at different prices, and deploy the dollar-cost averaging investment strategy.
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5 Advantages of Dollar-Cost Averaging
Here are five advantages to dollar-cost averaging that can help you boost your portfolio:
1. Low-Stress Investing
If you are deploying an investment strategy that wants you to invest in both stock market booms and recessions, you remove the decision fatigue about when to invest. For dollar-cost-averaging investors, removing the stress of when to invest makes for more consistent investing.
2. Consistent Investing
Investing consistently over the long term is one of the proven ways to increase your net worth. Dollar-cost averaging advocates for consistent investing, which makes this strategy a smart money habit.
3. Removes Pricing Risk
Pricing risk is the risk associated with a stock price decline. Purchasing stock regularly mitigates this risk because your portfolio will reflect the weighted average price of your purchases. This removes a single point in time transaction price risk.
4. Eliminates Emotions
Investing is emotional. Remaining objective about when to buy investments like stocks, mutual funds, or ETFs is essential for crisp decision-making
5. Long-Term Approach
Billionaire investors, like Warren Buffet, continuously remind investors that investing for the long term is the key to financial success. Dollar-cost averaging is one of the best strategies for beginner investors.
Smart Tip:
Dollar-cost averaging helps remove decision fatigue from investing. Investing at regular intervals is a powerful tool because of compound interest. However, a recent study by Vanguard looked at the total returns of lump-sum investing versus dollar-cost averaging [1]. The data suggest lump-sum investing could outperforms dollar-cost averaging. Consider your risk appetite and investment time horizon before choosing an investment strategy.
Example of Dollar-Cost Averaging
Dollar-cost averaging can be used to consistently invest in stocks you love, like high-yielding dividend stocks. Here is a practical example of using the dollar-cost averaging method versus purchasing the stock in one lump sum.
In this scenario, you buy $1,000 worth of the company Dividend Express each quarter. We will compare that to purchase $4,000 of Dividend Express during the first quarter
| Period | Share Price | Dollar Cost Averaging | Shares Purchased | Lump Sum Investment | Shares Purchased |
| Quarter 1 | $100 | $1,000 | 10 | $4,000 | 40 |
| Quarter 2 | $90 | $1,000 | 11.11 | $0 | 0 |
| Quarter 3 | $80 | $1,000 | 12.5 | $0 | 0 |
| Quarter 4 | $120 | $1,000 | 8.33 | $0 | 0 |
| Total | $4,000 | 41.94 | $4,000 | 40 |
The cost basis for the shares purchased using the dollar-cost averaging strategy was $95.37 per share, while the cost basis for the shares purchased using the lump sum was $100 per share. Using the dollar-cost averaging method in this scenario allowed you to accumulate more shares and lower your cost basis by continuously purchasing shares at the beginning of each quarter.
Smart Summary
The dollar-cost averaging method of investing should fit into your portfolio’s investment strategy, including your risk appetite. Making a single point in time stock purchase can certainly be a viable long-term investing approach if you are willing to accept the risk profile.
Dollar-cost averaging can be a viable strategy in volatile markets for both seasoned and new investors. It reduces the emotional aspect of investing in favor of cadenced and objective investing and is best for investors who want to remove their emotions from their investment decision-making. Dollar-cost averaging is a fantastic strategy for creating long-term wealth.
[1] Vanguard. Cost averaging: Invest now or temporarily hold your cash? Last accessed March 26, 2024.
