What is Dollar Cost Averaging?
Dollar Cost Averaging (DCA) is an investment strategy where you invest a fixed amount of money at regular intervals, regardless of the asset's price. This approach helps reduce the impact of volatility and removes the emotional aspect of trying to time the market.
How DCA Works
- When prices are high: Your fixed investment buys fewer shares
- When prices are low: Your fixed investment buys more shares
- Over time: Your average cost per share tends to be lower than the average price
Benefits of Dollar Cost Averaging
- Reduces Timing Risk: No need to predict market tops or bottoms
- Emotional Discipline: Removes emotion from investment decisions
- Automatic Investing: Easy to set up recurring investments
- Accessible: Start investing with small amounts
- Builds Habit: Encourages consistent saving behavior
DCA vs Lump Sum Investing
Studies show that lump sum investing outperforms DCA about two-thirds of the time, since markets tend to go up over time. However, DCA offers psychological benefits:
- Reduces regret if markets drop after investing
- Easier for those who don't have a lump sum available
- Better for risk-averse investors
- Matches how most people invest (from paychecks)
Best Practices for DCA
- Choose a consistent investment schedule
- Invest in low-cost index funds for diversification
- Automate your investments when possible
- Stay committed regardless of market conditions
- Review and rebalance your portfolio periodically
Common DCA Frequencies
- Weekly: Good for active investors with regular income
- Bi-Weekly: Aligns with many paycheck schedules
- Monthly: Most common, easy to manage
- Quarterly: Suitable for larger, less frequent investments