Dollar Cost Averaging Explained

You want to invest, but aren’t sure how to begin? Dollar cost averaging may be a viable strategy worth considering. Investors of all experience levels use the strategy to manage price risk while maximizing their purchasing power, especially in volatile markets.  

In this article, we’ll discuss the benefits and drawbacks of dollar cost averaging, and how you can make the most of this popular investment strategy.

What Is Dollar Cost Averaging?

Dollar cost averaging is a systematic investment strategy where you invest money at regular intervals, in the same or similar amounts each time instead of making a lump sum purchase all at once. Put another way, you buy assets, such as stocks, ETFs, or cryptocurrencies, in small, planned purchases, regardless of the price. 

Dollar cost averaging works like this:

  1. You decide on the amount you want to invest over time, say, $10,000 total

  2. You pick the type of asset in which you want to invest

  3. You choose the timing and frequency of your purchases, such as monthly for one year

  4. You determine the amount that you would like to invest in each interval, say $500 per week

  5. You stick to the schedule for the duration of time, or until you have invested your goal amount

It’s that simple.

In this way, dollar cost averaging potentially helps reduce the impact of short-term market volatility on your investments over time. You end up buying more of an asset when prices are low, and less when prices are high. Investing in a consistent, disciplined cadence helps you manage risk and uncertainty, whether markets are up or down.

Dollar Cost Averaging: An Example

Here’s a hypothetical example to illustrate how dollar cost averaging works. Say you want to invest $10,000, and you’ve identified an asset you want to purchase. However, you don’t have an exact purchase price in mind. So you decide to invest $2,000 a month for five months.  

The table below shows how your strategy might work:

After investing the entire $10,000, you purchased a total of 338.23 shares at an average price of $29.60, a slight discount to the $30 entry price. Comparatively, if you’d invested $10,000 in a lump sum at the initial $30 price, you’d have purchased 333.33 shares. By spreading your investment over five months instead of investing all at once, you ended up buying a few more shares while saving 40 cents per share. 

Dollar Cost Averaging vs. Timing the Market

Why not just buy when asset prices are at their lowest? While that may seem like a logical approach, when it comes to investing, there’s no such thing as “perfect timing.” No one can predict when prices will hit their lowest point. Even professional investors and money managers don’t get it right 100 percent of the time.

On the other hand, dollar cost averaging can help alleviate some of the stress and effort of having to watch the market's every move in an effort to time your entry perfectly—known as “market timing.” Instead, you can “set it and forget it,” purchasing assets at regular intervals without emotion or hesitation—attributes that may otherwise be detrimental to your investing success. This approach also helps you avoid missing out on potential buying opportunities, which can also negatively impact your long-term investment performance.

Why Dollar Cost Averaging Works

Implementing a dollar cost averaging strategy is an easy way to build your positions in a particular asset over time without taking on outsized risk. You simply purchase the same amount steadily at your chosen frequency without buying too low or too high. 

If the price of the asset drops after your initial investment, this presents an opportunity to buy more at a lower price, producing an average price below the original amount but above the second purchase price. By using dollar cost averaging and spreading your investment out over weeks or months, you reduce the potential impact of market volatility on your portfolio while putting your money to work for you on a consistent basis.

Dollar cost averaging can help remove the emotion out of the investment decision process. Committing to a predetermined strategy can help prevent you from chasing an asset higher when prices are on the rise, or selling in a panic when prices are falling.

The Drawbacks of Dollar Cost Averaging

While dollar cost averaging is a time-tested strategy many investors use to manage market risk and volatility, there are downsides. If the price of an asset rises steadily during the timeframe you’ve designated for your dollar cost averaging program, you may buy fewer shares than if you’d invested a lump sum at the start.

You may also pay higher transaction costs when you make multiple, systematic purchases over time. Depending on your investment strategy and the type of asset you decide to purchase, these expenses may offset any anticipated gains in your portfolio.

Although following a dollar cost averaging strategy is generally considered a smart way to reduce risk, the trade-off is that it may lead to lower returns over time. According to a study from investment advisor Vanguard, historically, 66% of the time, a lump sum investment would have produced greater returns than a dollar cost averaging approach. 

That said, not everyone has the money to invest all at once, and waiting to get into the market could mean you’ll miss out on potential gains. In addition, if you’re anxious about investing a larger amount of money at one time, dollar cost averaging may allow you to sleep better at night. 

Dollar Cost Averaging and Crypto

Cryptocurrencies are considered volatile investments. As such, if you’re seeking to mitigate market volatility for investing in the crypto market, dollar cost averaging may be a strategy worth considering. 

Although dollar cost averaging may be lower risk and lower reward, it provides you with a potential opportunity to profit in the long term, even if crypto markets experience sharp upturns or pullbacks. Generally speaking, buying the dips and selling high can generate potentially higher profits, but being fully in tune with the crypto market every minute of every day to capitalize on these price movements may not be the right approach for every investor. With dollar cost averaging, you have an opportunity to invest in crypto and ride out the highs and lows. This approach is one way to take advantage of market swings with relatively less risk and stress. 

If you want to invest in crypto or other market assets for the long term, consider whether dollar cost averaging is appropriate for you.    

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