Dollar-Cost Averaging (DCA) (2024)

Unit cost averaging, incremental averaging, or cost average effect

Written byCFI Team

Dollar-cost averaging (DCA) is an investment strategy in which the intention is to minimize the impact of volatility when investing or purchasing a large block of a financial asset or instrument. It is also called unit cost averaging, incremental averaging, or cost average effect. In the UK, it is referred to as pound cost averaging.

Dollar-Cost Averaging (DCA) (1)

DCA is a strategy in which instead of making one lump-sum purchase of a financial instrument, the investment is divided into smaller sums that are invested separately at regular predetermined intervals until the full amount of capital is exhausted.

The volatility of a financial instrument is the risk of upward or downward movement, which is inherently present in financial markets. DCA minimizes volatility risk by attempting to lower the overall average cost of investing.

Example

An investment of $200,000 in equities using DCA can be made over eight weeks by investing $25,000 every week in subsequent order. The table below illustrates the trades for lump-sum investment and DCA strategy:

Dollar-Cost Averaging (DCA) (2)

The total amount spent is $200,000, and the total number of shares purchased with a lump-sum investment is 2,353. However, under the DCA approach, 2,437 shares are purchased, representing a difference of 84 shares worth $6,888 at the average share price of $82. Therefore, DCA can increase the number of shares purchased when the market is declining and can lead to fewer shares purchased if the share price is rising.

The dollar-cost averaging example above is better explained diagrammatically as below:

Dollar-Cost Averaging (DCA) (3)

Variants of Dollar-Cost Averaging

Variant strategies for dollar-cost-averaging to maximize profits include scaled-up buying of securities in a downtrend market instead of a fixed amount and periodic purchase. Conversely, in an uptrend market, where shares are bullish, a scaled plan to sell is adopted.

Benefits of Dollar-Cost Averaging

1. Risk reduction

Dollar-cost averaging reduces investment risk, and capital is preserved to avoid a market crash. It preserves money, which provides liquidity and flexibility in managing an investment portfolio.

DCA avoids the disadvantage of lump-sum investing through the purchase of a security when its price is artificially inflated due to market sentiment, which results in the purchase of a lower than required quantity of a security. When the security price discovers its intrinsic price through a market correction or the bubble bursts, an investor’s portfolio will decline.

Some downturns are prolonged, further diminishing portfolio net worth. Using DCA ensures minimum loss and possibly high returns. DCA can reduce regret feelings through its provision of short-term, downside protection against a swift deterioration in a security price.

A declining market is often viewed as a buying opportunity; hence, DCA can significantly boost long-term portfolio return potential when the market starts to rise.

2. Lower cost

Buying market securities when prices are declining ensures that an investor earns higher returns. Using the DCA strategy ensures that you buy more securities than if you had purchased when prices were high.

3. Ride out market downturns

Using the DCA strategy by investing periodic smaller amounts in declining markets assists in riding out market downturns. The portfolio using DCA can keep a healthy balance and leave the upside potential to increase portfolio value in the long term.

4. Disciplined saving

The strategy of adding money regularly to an investment account allows disciplined saving, as the portfolio balance increases even when its present assets are depreciating. However, a prolonged market decline can be detrimental to the portfolio.

5. Prevents bad timing

Market timing is not a pure science that many investors, even professional ones, can master. Investing a lump sum at the wrong time can be risky, which can adversely affect a portfolio’s value significantly. It is difficult to predict market swings; hence, the dollar-cost averaging strategy will provide a smoothening of the cost of purchase, which can benefit the investor.

6. Manage emotional investing

The phenomena of emotional investing brought about by various factors – such as making a huge lump-sum investment and loss aversion – is not unusual in behavioral theory. The use of DCA eliminates or reduces emotional investing.

A disciplined buying strategy through DCA makes the investor focus their energy on the task at hand and eliminates news and information hype from various media about the stock market’s short-term performance and direction.

Criticisms of Dollar-Cost Averaging

Sufficient evidence exists that DCA can reduce the average dollar cost if applied with discipline and when favorable market conditions exist. However, other studies dispute the advantages, as well as the feasibility of conducting the DCA investment strategy successfully.

1. Higher transaction costs

By systematically purchasing securities in small amounts over a certain period, investors run the risk of incurring high transaction costs, which can have the potential to offset the gains accrued by the current assets in the portfolio.

However, it will largely depend on the type of investment strategy, as some mutual funds come with a high expense ratio, which can adversely affect portfolio value in the medium- to long-term period.

2. Asset allocation priority

DCA critics argue that an investment strategy should focus on the desired asset allocation to manage risk. Pursuing a DCA will further worsen uncertainty, as target asset allocation parameters will take longer to be reached. The economic and physical environments change over time; hence, investors should be able to flexibly realign their portfolios to protect against loss and take advantage of new opportunities.

However, for an investor pursuing DCA, the opportunity may be untenable. It is prudent for investors to place funds in a money market investment account-earning interest and awaiting profitable deployment to other strategic assets within the new desired asset allocation.

3. Low expected returns

The theory of the risk and return dynamics is simple – high risk-high returns and low risk-low returns. Hence, following a DCA strategy to reduce risk will inevitably lead to lower returns. The market typically experiences longer sustained bull markets of rising prices than the opposite. Thus, a DCA investor is more likely to lose out on asset appreciation and greater gains than one that invests a lump sum.

The odds of not being able to attain increased returns are greater than the odds of avoiding overall portfolio value erosion. A study by U.S.-based investment advisor Vanguard in 2012 revealed that historically 66% of the time, a lump-sum investment would’ve produced much higher returns than DCA.

4. Complicated

The task of monitoring each scheduled investment over a given time horizon by DCA is a complicated process, especially if, in the end, the difference compared to a lump-sum investment in terms of cost is negligible. The monitoring and tracking of each contribution incur time and energy, making it more complicated than a lump-sum investment.

Conclusion

Dollar-cost averaging (DCA) comes with benefits and drawbacks; however, the desire for a low-risk investment strategy may lead to lower returns.

On the benefits side, it’s possible to achieve a lower dollar-cost average for a security over time rather than a lump-sum investment, provided there are declining markets that do not become protracted.

An investor should aim to include DCA as an optional strategy, among other bolder strategies such as target asset allocation, diversification, and regular portfolio rebalancing.

Additional Resources

Thank you for reading CFI’s guide on Dollar-Cost Averaging (DCA). To help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

  • Diversification
  • Guide to Growth Investing
  • Tactical Asset Allocation
  • Investing: A Beginner’s Guide
  • See all wealth management resources
  • See all capital markets resources
Dollar-Cost Averaging (DCA) (2024)

FAQs

Dollar-Cost Averaging (DCA)? ›

Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

What is DCA cost averaging? ›

Dollar cost averaging is a strategy to manage price risk when you're buying stocks, exchange-traded funds (ETFs) or mutual funds. Instead of purchasing shares at a single price point, with dollar cost averaging you buy in smaller amounts at regular intervals, regardless of price.

Is DCA a good strategy? ›

DCA is a good strategy for investors with lower risk tolerance. If you have a lump sum of money to invest and you put it into the market all at once, then you run the risk of buying at a peak, which can be unsettling if prices fall. The potential for this price drop is called a timing risk.

Is value averaging better than DCA? ›

Value averaging most often provides a lower average cost per share than does DCA, and also provides for a higher internal rate of return (IRR). This does not, however, mean that value averaging will result in a higher realized profit.

Is it better to DCA or lump sum? ›

The data shows lump-sum investing often works in favour of investors. But if you are finding it hard to get back into the market, a DCA strategy can help you take that important first step. It can also provide a smoother investment experience.

What are the pros and cons of dollar-cost averaging DCA? ›

The advantages of dollar-cost averaging include reducing emotional reactions and minimizing the impact of bad market timing. A disadvantage of dollar-cost averaging includes missing out on higher returns over the long term.

How often should I dollar-cost average? ›

What is dollar-cost averaging? Dollar-cost averaging is the practice of putting a fixed amount of money into an investment on a regular basis, typically monthly or even bi-weekly. If you have a 401(k) retirement account, you're already practicing dollar-cost averaging, by adding to your investments with each paycheck.

What is the best day to DCA? ›

The Best Day to Weekly DCA Bitcoin

Similar to the best time of the day to DCA, we also found a weekly pattern. Since 2010, Mondays have had the highest odds of having the weekly low price relative to the weekly high price falling on this day. This pattern holds up over the last 12 months.

Why i don t recommend dollar-cost averaging? ›

The Market Rises Over Time

If you don't increase your monthly investment over time, you may end up with fewer and fewer shares on average. If you can afford to make a lump-sum investment instead of dollar cost averaging, you could come out ahead if your timing is right.

What are the 3 benefits of dollar-cost averaging? ›

Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

What are the disadvantages of dollar-cost averaging down? ›

Disadvantages of Averaging Down

Averaging down is only effective if the stock eventually rebounds because it has the effect of magnifying gains. However, if the stock continues to decline, losses are also magnified.

What are the pros of dollar-cost averaging DCA? ›

Investors who use a dollar-cost averaging strategy will generally lower their cost basis in an investment over time. The lower cost basis will lead to less of a loss on investments that decline in price and generate greater gains on investments that increase in price.

Can I dollar cost average with Charles Schwab? ›

Arrange regular, ongoing investments of $100 or more in any Schwab Mutual Fund OneSource®7 fund you purchase through your PCRA. Schwab makes it easy to take advantage of dollar-cost averaging.

Is buying dips better than DCA? ›

Deciding between dollar cost averaging vs buying the dip ultimately hinges on your risk tolerance, investment goals, and engagement level with the market. While DCA provides a steady, lower-risk path, buying the dip offers the potential for greater returns, demanding more attention and risk acceptance.

What is the DCA method? ›

DCA is a strategy in which instead of making one lump-sum purchase of a financial instrument, the investment is divided into smaller sums that are invested separately at regular predetermined intervals until the full amount of capital is exhausted.

What does DCA stand for? ›

Dollar-cost averaging (DCA) is the automatic investment of a set monetary amount on a periodic basis.

What is the DCA strategy? ›

What is Dollar Cost Averaging? Dollar Cost Averaging (DCA) is an investment strategy where rather than investing all the available capital at once, incremental investments are gradually made over time.

How is DCA calculated? ›

The calculation for dollar-cost averaging works the same as calculating the average or mean for a set of numbers. In the case of DCA, the investor adds investment purchase prices, then divides the sum by the amount of purchases made.

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