Dollar-Cost Averaging: How To Build Wealth Over Time | Bankrate (2024)

Dollar-cost averaging is one of the easiest techniques to boost your returns without taking on extra risk, and it’s a great way to practice buy-and-hold investing. Dollar-cost averaging is even better for people who want to set up their investments and deal with them infrequently. It’s one of the most powerful and easy investment strategies and it’s great for individual investors.

Here’s what dollar-cost averaging is and how to use it to maximize your investment gains.

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.

By doing this over time, you’re spreading out buy points and avoiding the practice of “timing the market.” Timing the market means dumping in all your money at one time, and it can be a dangerous practice if you end up investing when a stock hits its high point — risking a huge loss if the stock falls from there. With dollar-cost averaging, you’ll be buying over time and averaging your purchase prices.

Dollar-cost averaging makes a volatile market work to your benefit. By adding money regularly, you’re going to buy at times when the market is lower, therefore lowering your average purchase price and actually acquiring more shares. When the market moves higher, your regular contribution will buy fewer shares, but you’ll already have shares from prior purchases, so you’ll still gain and won’t completely miss out.

Plus, dollar-cost averaging can offer other benefits. People become fearful when stocks fall, and so to avoid more short-term losses, they stop buying stocks when they get cheap. By setting up a regular buying plan when the markets (and you) are calm, you’ll avoid this psychological bias and take advantage of falling stock prices when everyone else becomes scared.

You can pile up even more shares if you reinvest your dividends, too, which also applies the principle of dollar-cost averaging to those quarterly dividend payouts. You’ll turn your cash dividends into more shares of stock over time, and you won’t have to do a thing once you set the program up. Slowly you’ll start earning dividends on your dividends!

It only takes a little bit of time upfront to set up a reinvestment plan. Then you put it on autopilot and let your broker handle everything else. And that’s great for individual investors who want to spend as little time as possible dealing with their investments.

Example of dollar-cost averaging

Imagine an employee who earns $3,000 each month and contributes 10 percent of that to their 401(k) plan, choosing to invest in . Because the price of the fund moves around, the number of shares purchased isn’t always the same, but each month $300 is invested. The table below shows this example over a 10-month period.

MonthContributionPrice of fundShares boughtShares heldTotal value

You can see that the value of the employee’s investments went up 8.4 percent on their $3,000 in total contributions, despite the fund only increasing 5 percent over the period. That’s because the employee was able to buy a greater number of shares when the price was lower, taking advantage of the market volatility.

Does dollar-cost averaging really work?

It can depend on your specific situation, but dollar-cost averaging has been a successful way for many people to invest over time. The question is about whether you should time your purchases based on market conditions or just buy consistently over time using the dollar-cost averaging method. Timing the market has proven to be very difficult and most people are better off with a consistent investment plan.

Another issue is that most people are investing money as they earn it, likely through a workplace retirement plan such as a 401(k). Dollar-cost averaging makes sense here because you’re investing what you can as soon as it’s available to be invested. However, if you inherited a large sum of money, say $100,000, you wouldn’t want to spread that out to be invested over years. In that scenario, it’s best to get it invested relatively quickly, but you could still spread out purchases over a few months to take advantage of potential volatility.

Disadvantages of dollar-cost averaging

The main disadvantage of dollar-cost averaging is that in a market that generally rises over time, you’ll likely be better off being fully invested as soon as possible. But because most people are saving and investing as they earn money, dollar-cost averaging is the next best option.

Another disadvantage is that you still need to pick good underlying investments. If you’re dollar-cost averaging into a poor investment, the way you bought in won’t save you. The approach works best with broad-based funds such as an S&P 500 index fund, which has performed well over long time periods.

How to dollar-cost average

There are two ways that you can set up dollar-cost averaging for your account: manually and automatically. If you opt for the manual route, you’ll just pick a regular date (monthly, bi-weekly, etc.) and then go to your broker, buy the stock or fund and then you’re done until the next date.

If you opt to go the automatic route, it requires a little more time upfront, but it’s much easier later on. Plus, it will be easier to continue buying when the market declines, since you don’t have to act. While setting up your automatic buying may seem like a chore, it’s actually easy.

Almost any broker can set up an automatic buying plan, so use Bankrate’s reviews of the major players to find brokers that provide other features such as great customer service and educational tools.

Here are the steps to make dollar-cost averaging fully automatic.

1. Choose your investment

First, you’ll want to determine what you’re buying. Do you want to buy stock? Or will you go with an exchange-traded fund (ETF) or mutual fund?

  • If you opt to buy an individual stock, it’s more likely to fluctuate significantly than a fund will. But it may be difficult to find a brokerage that allows you to buy stocks on autopilot.
  • If you buy a fund, it should fluctuate less than an individual stock and it’s also more diversified, so you won’t be hurt as much if any single stock in the fund declines a lot.

Less-experienced investors usually opt for a fund, and some of the most diversified funds are based on the Standard & Poor’s 500 index. This index includes hundreds of companies across all major industries, and it’s the standard for a diversified portfolio of companies. If you want to buy an S&P index fund, here are some of the top choices.

In either case, you’ll need to note the ticker symbol for the security; that’s the short-hand code for the stock or fund.

2. Contact your broker

So, you’ve made your choice of investment. Now see if your broker will allow you to set up an automatic purchase plan for that investment. If so, then you’re ready to move on to the next step.

However, some brokers allow you to set up an automatic plan only with mutual funds. In that case, you might consider opening another brokerage account that allows you to do exactly what you want. There are other solid advantages to having multiple brokerage accounts, too, and you can usually get a lot of value by having multiple accounts.

3. Determine how much you can invest

Now that you’ve got a broker who can execute your automatic trading plan, it’s time to figure out how much you can regularly invest. With any kind of stock or fund, you want to be able to leave your money in the investment for at least three to five years.

Since stocks can fluctuate a lot over short periods, try to allow the investment some time to grow and get over any short-term declines in price. That means you’ll need to be able to live only on your uninvested money during that time.

So starting with your monthly budget, figure how much you can devote to investing. Once you have an emergency fund in place, how much can you invest and not need? Even if it’s not a lot at first, the most important point is to begin investing regularly.

Dollar-cost averaging is now cheaper than ever, since all major brokers now charge no commissions on stock and ETF trades and the best brokers for mutual funds allow you to skip the fees for thousands of mutual funds. That means you really can start with any amount of money and begin building your nest egg.

4. Schedule your automatic plan

You can set up the automatic trading plan at your broker using the ticker symbol for the stock or fund, how much you want to purchase on a regular basis and how often you want the trade to execute. The exact process for setting this up varies by broker, but these are the basics that you’ll need in any case. If you have further questions, your broker can help.

And if your stock or fund pays dividends, it can be a good time to set up automatic dividend reinvestment with your broker. Any cash dividend will be used to purchase new shares, and you can often even buy fractional shares — putting the whole value of the dividend to work, rather than having it sit for a long time in cash earning little or next to nothing. So even as soon as the next dividend, your dividend will be earning dividends.

Bottom line

Dollar-cost averaging is a simple way to help reduce your risk and increase your returns, and it takes advantage of a volatile stock market. If you set up your brokerage account to buy stocks or funds automatically and regularly, then you can sit back and do the things you love, rather than spend your time investing. In investing, you can often get better results with less effort.

Note: Bankrate’s Brian Baker contributed to an update of this story.

Dollar-Cost Averaging: How To Build Wealth Over Time | Bankrate (2024)


Dollar-Cost Averaging: How To Build Wealth Over Time | Bankrate? ›

“Dollar-cost averaging” means investing regular amounts over time instead of investing all your money in a fund at once. Imagine if you invest $10,000 tomorrow and the stock drops 20%. At $8,000, it will need to increase 25% (not 20%) to get back to $10,000.

Does Warren Buffett use dollar-cost averaging? ›

Among the numerous investment strategies available, dollar-cost averaging is a popular and widely used approach. Its proponents range from Warren Buffett to average investors.

What are the 2 drawbacks to dollar-cost averaging? ›

Cons of Dollar Cost Averaging
  • You Could Miss Out on Certain Opportunities. Investing in the same stock or fund every month could cause you to miss out on other investment opportunities. ...
  • The Market Rises Over Time. ...
  • It Could Give You a False Sense of Security.
Sep 12, 2023

Is DCA good for long term investment? ›

The market rises over time

One disadvantage of dollar-cost averaging is that the market tends to go up over time. Thus, investing a lump sum earlier is likely to do better than investing smaller amounts over a long period of time.

How do you make money with dollar-cost averaging? ›

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.

What is Warren Buffett's 90 10 rule? ›

Warren Buffet's 2013 letter explains the 90/10 rule—put 90% of assets in S&P 500 index funds and the other 10% in short-term government bonds.

How often should you invest with dollar cost averaging? ›

Consistency trumps timing

It sounds technical, but dollar cost averaging is quite simple: you invest a consistent amount, week after week, month after month (think payroll contributions going into your 401(k) account) regardless of whether the markets are up, down or sideways.

What is better than dollar-cost averaging? ›

When you put all your money in at once, you're more likely to see results quickly. This can be a helpful motivator for a beginning investor. You will often see higher returns with lump sum investing compared to dollar-cost averaging.

Why dollar-cost averaging doesn t work? ›

When you're doing dollar cost averaging, you're not keeping your money in the market over the full period of time. You are keeping much of your money out of the market for much of the time. So, you're not getting the full benefit of long-term investing.

Is it better to invest all at once or monthly? ›

Lump-sum investing is usually the better choice

There has been plenty of research done on this subject, so we have an answer on which investment strategy is better. Lump-sum investing outperforms dollar-cost averaging about two-thirds (68%) of the time, according to Vanguard.

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 is the best time period for DCA? ›

They contrast the relative benefits of DCA versus never investing the lump sum or making the change. One study found that the best time horizon when delaying investing a windfall in the stock market in terms of balancing return and risk is 6 or 12 months.

Is dollar cost averaging good for retirement? ›

Dollar-cost averaging is one of the easiest techniques to boost your returns without taking on extra risk, and it's a great way to practice buy-and-hold investing. Dollar-cost averaging is even better for people who want to set up their investments and deal with them infrequently.

What is the smartest thing to do with a lump sum of money? ›

Saving with a savings account

Cash savings are always popular with people who want to put away a lump sum and earn interest over a long period of time. This can be a very good way to save for things without taking on bigger levels of risk.

How long should you do dollar cost averaging? ›

Another issue with DCA is determining the period over which this strategy should be used. If you are dispersing a large lump sum, you may want to spread it over one or two years, but any longer than that may result in missing a general upswing in the markets as inflation chips away at the real value of the cash.

What to do with 50k lump sum? ›

How to invest $50,000
  1. Look into investment accounts. ...
  2. Explore low-cost investments. ...
  3. Consider diversifying your assets. ...
  4. Max out your retirement accounts. ...
  5. Optimize for tax implications. ...
  6. Invest for more than retirement. ...
  7. Chat with an advisor.
Apr 2, 2024

What is the dollar-cost averaging strategy of Warren Buffett? ›

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.

Who uses dollar-cost averaging? ›

Dollar-cost averaging is even better for people who want to set up their investments and deal with them infrequently. It's one of the most powerful and easy investment strategies and it's great for individual investors. Here's what dollar-cost averaging is and how to use it to maximize your investment gains.

Is dollar-cost averaging a good strategy now? ›

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.

Does dollar-cost averaging still work? ›

In addition, dollar cost averaging still helps your money grow. In the Financial Planning Association's and Vanguard's research, investors who used dollar cost averaging did see significant investment growth—just slightly less most of the time than if they had invested a lump sum.

Top Articles
Latest Posts
Article information

Author: Pres. Lawanda Wiegand

Last Updated:

Views: 5621

Rating: 4 / 5 (71 voted)

Reviews: 86% of readers found this page helpful

Author information

Name: Pres. Lawanda Wiegand

Birthday: 1993-01-10

Address: Suite 391 6963 Ullrich Shore, Bellefort, WI 01350-7893

Phone: +6806610432415

Job: Dynamic Manufacturing Assistant

Hobby: amateur radio, Taekwondo, Wood carving, Parkour, Skateboarding, Running, Rafting

Introduction: My name is Pres. Lawanda Wiegand, I am a inquisitive, helpful, glamorous, cheerful, open, clever, innocent person who loves writing and wants to share my knowledge and understanding with you.