Investing can feel intimidating, especially when the market is unpredictable, and you’re unsure when to dive in.
That’s where dollar-cost averaging (DCA) comes in – a simple yet powerful strategy that even seasoned investors swear by.
In this post, you’ll learn:
- What dollar-cost averaging is and how it works.
- Who should use it and why.
- How to set up your own DCA strategy step-by-step.
Curious how it works and if it’s right for you?
Let’s dive in!
What is dollar-cost averaging (DCA) & how does it work?
It’s a simple, systematic approach to investing that removes the guesswork and helps you stay consistent, regardless of how the market behaves.
At its core, DCA involves investing a fixed amount of money into a particular asset or portfolio at regular intervals.
This could be weekly, monthly, quarterly, or any schedule you choose.
No matter whether prices are soaring or dipping, you’ll keep investing the same amount, automatically buying more shares when prices are low and fewer when prices are high.
Over time, this strategy smooths out the ups and downs of the market, effectively averaging your purchase cost.
Benefits of dollar-cost averaging
Reduces the average cost of investments over time
By spreading out your purchases over time, you naturally buy more units when prices are low and fewer when prices are high.
For instance, if you’re investing $200 a month into a mutual fund, you’ll accumulate more units during market dips, ultimately lowering your average purchase price.
This approach protects you from investing a large sum at an unfavourable time.
Promotes consistent and disciplined investing
DCA encourages a disciplined approach to investing.
By committing to regular contributions, you develop the habit of setting aside money for your financial future, much like saving but with the added potential for growth.
Over time, this consistency builds wealth – even if you’re starting with small amounts.
Simplifies investing by automating the process
By automating your regular contributions – weekly, monthly, or quarterly – you eliminate the hassle of manually buying assets.
Most brokers and financial institutions allow you to set up automatic plans for as little as $100 a month.
This “set it and forget it” approach simplifies your financial life, leaving you more time to focus on other priorities.
Eliminates the risks of trying to time the market
Timing the market is notoriously difficult, even for experienced investors.
DCA eliminates this challenge by prioritising time in the market over perfect entry points.
As DBS explains, DCA helps you avoid the stress of guessing market highs and lows, providing a more predictable and less risky path to investing.
Ensures readiness to capitalise on market opportunities
With DCA, you’re always in the market and ready to benefit from upward trends.
When prices rise after a period of decline, the shares you’ve accumulated at lower costs will appreciate in value, boosting your portfolio’s overall performance.
This readiness to seize market opportunities is a key advantage of sticking with the strategy over the long term.
Removes emotional biases, protecting portfolio returns
Investing often triggers emotional reactions – fear during downturns and greed during rallies.
These impulses can lead to costly mistakes, like panic-selling at a loss or overinvesting at a peak.
DCA protects you from such errors by automating your investments, helping you stick to your plan regardless of market conditions.
This reduces the impact of volatility on your portfolio and fosters rational decision-making.
Cons of dollar-cost averaging
Higher costs of transactions
DCA involves making regular investments over time, which can result in higher transaction fees depending on your brokerage account.
For example, if your broker charges a flat fee for every trade, investing $200 monthly over a year incurs 12 separate fees, which could add up.
On the other hand, a lump-sum investment incurs only one transaction fee, making it more cost-efficient in certain cases.
That said, many brokers now offer commission-free trades or low-cost automatic investment plans, reducing this impact significantly.
Missed opportunities in dividend-paying assets
When investing in dividend-paying assets, such as stocks or mutual funds, DCA could lead to missed opportunities for maximising returns.
With a lump-sum investment, your entire amount starts generating dividends immediately.
In contrast, with DCA, only the portion of your capital already invested will earn dividends, potentially reducing compounding returns in the early stages.
If dividends are a critical part of your investment strategy, this trade-off should be carefully considered.
Lump-sum investing can perform better over time
Historically, lump-sum investing has outperformed DCA in upward-trending markets.
Research shows that markets tend to rise over the long term, which means investing a large amount upfront allows your money to start working immediately.
For instance, studies cited by DBS highlight that lump-sum investing captures more of the market’s upward momentum compared to spreading out contributions.
However, this comes with higher risk, especially if the market experiences a downturn shortly after your lump-sum investment – highlighting the importance of choosing the right investment choices based on your time horizon.
How often should I dollar cost average?
Monthly contributions
This is by far the most popular method, especially for salaried individuals.
Monthly DCA aligns perfectly with payday schedules, allowing you to allocate a fixed portion of your income towards investments without disrupting your budget.
For example, if you receive your pay at the end of every month, you could invest $200 consistently into an exchange-traded fund (ETF) or mutual fund.
This regularity also helps build disciplined investing habits over time.
Bi-weekly contributions
For those who get paid every 2 weeks, a bi-weekly contribution might make more sense.
This approach allows you to invest smaller amounts more frequently, potentially taking advantage of more price fluctuations.
It’s also great for smoothing out market volatility further, as you’re entering the market at more intervals.
Quarterly contributions
If you prefer a less frequent but systematic approach, quarterly contributions could be your choice.
This is particularly suitable for investors who rely on quarterly dividends, bonuses, or other periodic income streams.
Although it’s less regular than monthly or bi-weekly investing, it still offers the benefit of spreading out your purchases over time.
As-and-when contributions
This approach is ideal for those with irregular income or who want to be opportunistic with their investments.
While not strictly “automatic” like the other methods, as-and-when contributions involve investing whenever you can spare the funds.
For instance, if you receive a tax refund, freelance income, or any unexpected windfall, you could add to your DCA strategy.
How to dollar-cost average?
1. Choose your investment
Will it be individual stocks, exchange-traded funds (ETFs), mutual funds, or a mix?
If you’re just starting, diversified options like ETFs or broad-based index funds (e.g., an S&P 500 fund) are popular choices.
These options minimise the risk tied to individual assets and are less volatile than individual stocks.
Remember that your choice should align with your financial goals, risk tolerance, and time horizon.
2. Choose a broker
Look for one that offers:
- Low or no transaction fees
- Automatic investment options
- A user-friendly platform
Most major brokers allow you to automate regular contributions.
Do your research and choose a platform that supports the asset classes you want to invest in and fits your budget.
3. Determine how much you can invest
Figure out how much money you can comfortably invest without affecting your day-to-day finances.
Review your monthly budget to see how much disposable income you can set aside.
I use my financial planning spreadsheet to help me determine any excess funds I can use to invest consistently.
Don’t overcommit – remember, DCA is about consistency over time, not investing large sums all at once.
4. Schedule your automatic plan
Once you’ve chosen your investment, broker, and budget, it’s time to automate.
Most brokers let you set up a recurring plan where funds are automatically deducted from your account at your chosen interval (monthly, bi-weekly, etc.).
Automation removes the hassle of manual investing and helps you stick to the plan, even during market fluctuations.
How to calculate your average cost per investment?
1. Track total investment amounts
First, record how much money you’ve invested in total.
This includes every contribution you’ve made over your DCA period.
Whether you’re investing $200 monthly or at irregular intervals, tally up the amounts.
2. Track total units purchased
Next, record how many units (or shares) you’ve purchased for each transaction.
This varies depending on the price at the time of purchase.
Units can often include fractional shares if your broker supports them.
For example, in January, you bought 4.5 units at $44.44 per share, in February, 5 units at $50 per share, and in March, 3.0 units at $50 per share.
Your total units purchased are 12.5.
3. Calculate the average cost per unit
Once you have your total investment amount and total units, plug them into the formula:
Average cost per unit = Total amount invested/Total units purchased
Using the example above:
- Total Amount Invested = $600
- Total Units Purchased = 12.5
Average cost per unit = 600/12.5 = 48
So, your average cost per unit is $48.
Who should use dollar-cost averaging?
New investors
If you’re new to investing and feeling overwhelmed by market complexities, DCA is a great starting point.
It removes the pressure of trying to time the market and allows you to focus on consistency.
By investing small, manageable amounts, you can build your portfolio steadily while learning the ropes of investing.
Long-term investors
DCA is ideal for those with long-term financial goals, such as retirement planning or saving for a major life event like your child’s education.
Over time, the strategy helps smooth out market fluctuations, ensuring that you steadily accumulate assets without worrying about short-term volatility.
Risk-averse investors
For those wary of taking big risks, DCA provides a safer way to enter the market.
By spreading your investments over time, you minimise the impact of sudden market drops.
It’s an effective way to reduce anxiety while participating in potential market growth.
Emotional investors
If you are driven by fear or greed when investing, DCA can help you stay on track.
Automating your contributions takes emotion out of the equation, so you don’t panic-sell during downturns or overinvest during market highs.
Investors in volatile markets
Volatility can be unsettling, but DCA turns it into an advantage.
By buying more units when prices are low and fewer when they’re high, you effectively lower your average cost.
This makes it a smart choice for those investing in markets prone to sharp fluctuations.
Passive investors
If you prefer a “set it and forget it” approach, DCA is perfect for you.
Automating your investments means less time spent tracking the market and more time focusing on other aspects of your life. It’s a stress-free way to grow your wealth steadily.
Frequently asked questions
Is dollar-cost averaging a good idea?
Dollar-cost averaging is a good idea for many investors, especially if you’re looking for a consistent and disciplined way to invest.
This strategy works by spreading your investments over time, which reduces the risk of buying assets at a high price and smoothing out market volatility.
It’s particularly helpful for new investors, risk-averse individuals, or anyone with a regular income who wants to build wealth steadily.
While it might not outperform lump-sum investing in consistently rising markets, it’s a reliable approach for those who value long-term growth without the stress of timing the market.
Should you always dollar-cost average?
You shouldn’t always dollar-cost average, as its effectiveness depends on your financial situation and market conditions.
Dollar-cost averaging works well if you’re investing over time, have a regular income, or prefer a consistent strategy to reduce the impact of market volatility.
However, in a consistently rising market, lump-sum investing may yield better returns since your money is fully invested sooner.
Additionally, if you have a large sum available and the market outlook is favourable, spreading it out through DCA might mean missing potential gains.
Ultimately, it’s about aligning your strategy with your goals and risk tolerance.
Can dollar-cost averaging make you rich?
Dollar-cost averaging can help you build wealth over time, but it’s not a get-rich-quick strategy.
By investing consistently, you take advantage of market fluctuations and lower your average cost, which can lead to steady growth.
However, the effectiveness of dollar-cost averaging depends on your chosen investments and the time horizon.
For long-term goals like retirement, DCA is a great way to accumulate wealth gradually.
That said, the key to financial success lies in smart investing, diversification, and patience – DCA is just one piece of the puzzle.
How long should your dollar-cost average be?
How long you should dollar-cost average depends on your financial goals and investment strategy.
Ideally, dollar-cost averaging works best over the long term, especially for goals like retirement or building wealth.
A period of 3 to 5 years is often recommended to allow your investments to ride out market volatility and benefit from growth.
However, if you’re investing a large sum, you might use DCA for a shorter period, such as a few months, to mitigate the risk of market dips.
The key is to match your DCA timeline with your financial objectives and comfort with risk.
Conclusion
Dollar-cost averaging (DCA) is a simple yet powerful investment strategy that works for many investors.
We’ve covered what DCA is, how it works, its benefits, and some of its drawbacks.
Whether you’re a new investor trying to ease into the market, a risk-averse saver looking for consistency, or someone navigating volatile markets, DCA offers a stress-free way to grow your wealth over time.
From calculating your average cost to choosing the right investment frequency, the key takeaway is that consistency matters more than timing.
Sure, it might not be perfect for every situation – especially if you have a lump sum ready to go – but it’s a proven way to build discipline and avoid emotional mistakes.
If you’re still unsure about how to get started or whether DCA is right for you, don’t stress!
You can connect with one of our trusted financial advisor partners for free.
They’ll help you weigh your options and create a personalised plan for your financial goals.
Investing doesn’t have to be overwhelming – sometimes, it just takes some guidance to get going.