Britannica Money (2024)

Dollar cost averaging is an investment strategy in which you divide the total amount you’d like to invest into small increments over time, in hopes of lowering the average price, and aim for better returns in the long run.

Have you ever decided to fill your gas tank just halfway, hoping to come back in a day or two and get a few more gallons at a lower price? Like the price of gasoline, stocks go up, but they also sometimes sink. If you buy a stock or a stock fund in smaller batches over weeks, months, or years with a dollar cost averaging investment strategy, you’ll accumulate shares at a range of prices instead of just one.

Key Points

  • Dollar cost averaging can help you accumulate more shares of a stock at a lower price.
  • If you have a 401(k), you may already be using a dollar cost averaging investment strategy.

In a market that’s falling, that means your investments over time might be cheaper on average than if you bought one large batch. Cheaper is better, provided it’s a quality stock that can bounce back. If the stock fluctuates, going up and down, you’ll buy fewer shares at higher prices and more shares at lower prices as you build your position. That can ultimately mean a better return on investment years later when you sell.

Dollar cost averaging can also be handy if you don’t have a huge chunk of cash ready to invest. Instead, you can build your position slowly, with smaller infusions over time.

How dollar cost averaging works

Here’s how to dollar cost average:

  • Pick a quality exchange-traded fund (ETF) or a diversified group of stocks.
  • Decide how much to invest and over what period of time.
  • Divide the total investment amount by the weeks or months you plan to use dollar cost averaging. For example, $20,000 over 20 months would mean $1,000 a month.
  • Invest the same amount each week or month, no matter the current stock price. Don’t get scared by a drop. Remember, that’s when you get more shares for your money.

You may be thinking, “Sure, but what if the stock goes up?” Well, if that happens, good for you. It was a solid investment. You’ll buy fewer shares at the higher price, simply because you spend the same amount each time. And you’ll gain from the stock’s gains, of course. The downside is you won’t gain as quickly as you would have if you bought all your shares at once. However, that might not have been an affordable option in the first place.

You might also think, “Why buy every month when I could just buy at the bottom?” That’s a common fallacy, unless you have a genuine crystal ball. Even expert investors have trouble “timing the market.” Dollar cost averaging keeps you in the market over time, and over the long haul that’s more important than trying to time a stock’s turnaround.

Dollar cost averaging example

Let’s follow two investors, Bill and Ruth, to see how a dollar cost average investment strategy works. Suppose company XYZ is trading for $100 per share, but the price tends to be quite volatile, gyrating up and down around that $100 price.

  • Bill gets a $20,000 bonus and decides to put it all into XYZ at today’s price of $100. He spends $20,000 for 200 shares.
  • Ruth likes the same stock, but she doesn’t have $20,000 to spend at one time. Instead, she spends $20,000 over the next 20 months, forking over $1,000 on the last day of each month. Let’s suppose, because of XYZ’s extreme volatility, in 10 of those months the prevailing price is $80 per share, and in the other 10 months it’s $120.

By following the dollar cost averaging strategy, Ruth was able to buy 12.5 shares at $80 per share. She also bought 8.3 shares at $120. Doing the math, after 20 months, Ruth has acquired 208 shares [(12.5 x 10) + (8.3 x 10) = 208]. Ruth bought 8 shares more than Bill for the same cash. Her average price was lower, at $96.15 [(125 x 80) + (83 x 120) ÷ 208 = $96.15].

This example is an oversimplification, but it illustrates the power of dollar cost averaging. Over the course of 20 months, that same $20,000 investment allowed Ruth to purchase more shares than Bill at a lower average cost.

You may already be a dollar cost average investor

Do you participate in your employer’s 401(k) plan, making monthly contributions into one or several mutual funds or ETFs? Then you’re buying the same fund over time as it goes up and down, probably without thinking about it (except when you check your annual statement).

When you make regular contributions to a 401(k), you buy incrementally at a range of prices—sometimes low, sometimes high—and you get more shares when prices are lower. It sounds like a dollar cost averaging investment strategy, because it is.

In the context of a 401(k), dollar cost averaging has another advantage. Remember that old phrase, “Out of sight, out of mind”?

Your 401(k) takes the same amount from your paycheck automatically each month and drops it into whichever investments you’ve designated, whatever the current price might be. If the price weakens, you continue accumulating shares at the lower prices. Unless you actively monitor your account’s performance, you might not even notice the drop, which can prevent you from losing your head and selling out of fear.

If your employer doesn’t offer a 401(k), you can follow a dollar cost averaging strategy in your individual retirement account (IRA) instead.

The bottom line

One of the biggest mistakes you can make as an investor is to let fear guide your decisions. The best investors hunker down in tough times and execute their plan. If you’re using a dollar cost averaging strategy, it’s during those tough times you’ll accumulate more shares. Although past performance is no guarantee, historically, market recoveries tend to reward the persistent.

Warren Buffett once said he gets greedy when others are fearful, and fearful when others are greedy. We’re not encouraging greed, but Mr. Buffett was essentially saying that when accumulating investments, be more aggressive when prices are low and less aggressive when they’re high.

That’s dollar cost averaging in a nutshell.

Britannica Money (2024)

FAQs

How do I know I have enough money? ›

“A good rule of thumb is to aim to have saved 25-30 times the amount you'll spend each year, less any guaranteed income sources.

What is Britannica money? ›

That's why we created Britannica Money—to help everyday investors and savers like yourself navigate the financial journey through every stage, from opening your first bank account to leaving a legacy for the grandkids.

What does it mean to have enough money? ›

The truth is that “enough” depends on our personal circ*mstances. Money is an emotional subject, not a rational one. A multi-six-figure earner can feel they're overwhelmed with material desires. While someone earning a fraction of that can feel perfectly satisfied with their life. It's all about what we think we need.

Who named money? ›

The English word money first appeared in the 14th century. It was derived from the Latin word moneta, a name given to the Roman goddess Juno, at or near whose temple the Romans first began minting coins around 300 BCE. (Read Milton Friedman's Britannica entry on money.)

How much money is truly enough? ›

Generally, $100,000 per year is a good goal for most people.

Of course, this is just a rule of thumb. If you live in a high-cost-of-living area like California or New York, you might need to make more than $100,000 to be comfortable. A lot more! And if you have a lot of debt, you'll need to make more to pay it off.

How much money should you have at what age? ›

Savings by age 30: the equivalent of your annual salary saved; if you earn $55,000 per year, by your 30th birthday you should have $55,000 saved. Savings by age 40: three times your income. Savings by age 50: six times your income. Savings by age 60: eight times your income.

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Are Britannica worth anything? ›

The Internet has rendered vintage encyclopedias obsolete and today the value is primarily from people looking to have a set similar to the one that they grew up with. A complete 1967 white britannica encyclopedia sells for $50 or so at auction and for $120 to $150 from antique book dealers.

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Visitors do have free access to a limited amount of digital content on Britannica.com. Britannica Kids, however, requires a premium membership to view content.

Is it enough money or enough of money? ›

Enough is an Adjective and Money is a Noun so an adjective is always used before the noun and that's why “enough money” is correct when used in a grammatically correct sentence.

Why do we need enough money? ›

Basic Needs: Money is essential for meeting our basic needs such as food, shelter, and clothing. Without money, it is impossible to obtain the things we need to survive. Education: Money plays a significant role in education. It enables us to pay for school fees, buy books, and access other educational resources.

Why I don't have enough money? ›

You may be overspending, or you may not make enough money, or maybe both. These problems can lead to real trouble. If you do not make enough to cover your bills, you will need to take steps now to increase your income. Even if you feel that you are too poor to make a plan, a budget can help you get back on track.

Who created the dollar? ›

After the U.S. Constitution was ratified, Congress passed the "Mint Act" of April 2, 1792, which established the coinage system of the United States and the dollar as the principal unit of currency. By this Act the U.S., became the first country in the world to adopt the decimal system for currency.

Who invented cash? ›

Historians generally agree that the Lydians were the first to make coins. However, in recent years, Chinese archaeologists have uncovered evidence of a coin production mint located in China's Henan Province thought to date to 640 B.C. In 600 B.C., Lydia began minting coins widely used for trading.

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