How to Use Dollar-Cost Averaging to Build Wealth Over Time (2024)

Dollar-cost averaging is a simple technique that entails investing a fixed amount of money in the same fund or stock at regular intervals over a long period of time.

If you have a 401(k) retirement plan, you're already using this strategy.

Make no mistake, dollar-cost averaging is a strategy, and it's one that can get results that are as good or better than aiming to buy low and sell high. As many experts will tell you, nobody can time the market.

Key Takeaways

  • Dollar-cost averaging requires the investor to invest the same amount of money in the same stock on a regular basis over time, regardless of the share price.
  • Over time, this strategy tends to achieve as good or better results than trying to time the market.
  • Dollar-cost averaging is a particularly attractive strategy for new investors with a limited stake. They can invest a little at a time over time, with good results.

How to Invest Using Dollar-Cost Averaging

The strategy couldn't be simpler. Invest the same amount of money in the same stock or mutual fund at regular intervals, say monthly. Ignore the fluctuations in the price of your investment. Whether it's up or down, you're putting the same amount of money into it.

This can even be done automatically by reinvesting a dividend payment back into the stock itself.

The number of shares purchased each month will vary depending on the share price of the investment at the time of the purchase. When the share value rises, your money will buy fewer shares per dollar invested. When the share price is down, your money will get you more shares.

Over time, the average cost per share you spend should compare quite favorably with the price you would have paid if you had tried to time it.

You might consider using the dollar-cost averaging strategy to invest in an exchange-traded fund or no-load mutual fund. That can give you the benefit of diversification.

Rewards of Dollar-Cost Averaging

In the long run, this is a highly strategic way to invest. Since you're buying more shares when the cost is low, you're reducing your average cost per share over time.

Dollar-cost averaging is particularly attractive to new investors just starting out. It's a way to slowly but surely build wealth even if you're starting out with a small stake.

Example of Dollar-Cost Averaging

For example, assume an investor deposits $1,000 on the first of each month into Mutual Fund XYZ, beginning in January. Like any investment, this fund bounces around in price from month to month.

In January, Mutual Fund XYZ was at $20 per share. By Feb. 1, it was at $16; by March 1, it was $12; by April 1, it was $17, and by May 1, it was $23.

The investor keeps steadily putting $1,000 into the fund on the first of each month while the number of shares that amount of money buys varies. In January, $1,000 bought 50 shares. In February, it bought 62.5 shares, in March it bought 83.3 shares, in April it was 58.2 shares, and in May it was 43.48 shares.

Just five months after beginning to contribute to the fund, the investor owns 298.14 shares of the mutual fund. The investment of $5,000 has turned into $6.857.11. The average price of those shares is $16.77. Based on the current price of the shares, the investment of $5,000 has turned into $6,857.11.

If the investor had spent the entire$5,000 at once at any time during this period, the total profit might be higher or lower. But by staggering the purchases, the risk of the investment has been greatly reduced.

Dollar-cost averaging is a less risky way to obtain a favorable price per share.

Why Use Mutual Funds

When it comes to using the dollar-cost averaging strategy there may be no better investment vehicle than the no-load mutual fund. The structure of these mutual funds, which are bought and sold without commission fees, could almost have been designed with dollar-cost averaging in mind.

The expense ratio that mutual fund investors pay is a fixed percentage of the total contribution. That percentage takes the same relative bite out of a $25 investment or regular installment amount as it would out of a $250 or $2,500 lump-sum investment.

For example, if you made a $25 installment payment in a mutual fund that charges a 20 basis-point expense ratio, you would pay a fee of $0.05, which amounts to 0.2%. For a $250 lump-sum investment in the same fund, you would pay $0.50, or 0.2%.

Several Fund Options for Dollar-Cost Averaging

Still, the availability of no-load mutual funds, which by definition do not charge transaction fees, combined with their low minimum investment requirements, offers access to investing to almost everyone. In fact, many mutual funds waive required minimums for investors who set up automatic contribution plans, the plans that put dollar-cost averaging into action.

To really cut the costs, you might consider index funds or exchange-traded funds (ETFs). These funds are not actively managed and are built to parallel the performance of a particular index. Since there are no management fees involved, the costs are a fraction of a percentage.

A Long-Term Strategy

Regardless of the amount you have to invest, dollar-cost averaging is a long-term strategy.

While the financial markets are in a constant state of flux, over long periods of time, most stocks tend to move in the same general direction, swept along by larger currents in the economy.

A bear market or a bull market can last for months or even years. That reduces the value of dollar-cost averaging as a short-term strategy.

In addition, mutual funds and even individual stocks don't, as a general rule, change in value drastically from month to month. You have to keep your investment going through bad and good times to see the real value of dollar-cost averaging. Over time, your assets will reflect both the premium prices of a bull market and the discounts of a bear market.

How to Use Dollar-Cost Averaging to Build Wealth Over Time (2024)


How to Use Dollar-Cost Averaging to Build Wealth Over Time? ›

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.

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 the best dollar-cost averaging strategy? ›

The strategy couldn't be simpler. Invest the same amount of money in the same stock or mutual fund at regular intervals, say monthly. Ignore the fluctuations in the price of your investment. Whether it's up or down, you're putting the same amount of money into it.

How would you explain dollar-cost averaging to a client and why is it important? ›

Dollar cost averaging helps investors become accustomed to fluctuations. “You're putting a regular amount to work in the market over time without regard to price,” says Haworth. “Sometimes prices will be higher, sometimes they'll be lower, but you essentially continue to accumulate investments.”

How often should you invest with dollar-cost averaging? ›

Dollar-cost averaging is pretty simple. Pick a stock, fund, or other asset; then decide on a fixed amount to invest in it regularly. With dollar-cost averaging, you invest a set amount in the same asset at regular intervals, such as once a month or every payday. It doesn't matter what the price of the investment is.

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

Build emergency savings

However you choose to invest your lump sum, it may also be a good idea to build an emergency savings pot. Typically, an emergency savings pot should cover about three months' salary and be quickly accessible so that you can use it whenever you need it.

Is it better to invest lump sum or monthly? ›

Investing a lump sum means that you don't have to try to figure out the best time to make periodic investments. You can set up your portfolio and let it grow. A 2021 Northwestern Mutual Life study showed that investing a lump sum generally outperforms dollar-cost averaging over various periods of time.

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

What is the best time frame for 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.

When should I start dollar-cost averaging? ›

You might consider dollar cost averaging if you're: Beginning to invest and only have smaller amounts to buy shares. Not interested in all the research that goes along with market timing. Making regular investments each month in retirement accounts, like an IRA or a 401(k).

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.

How do investors benefit from dollar-cost averaging? ›

But they could end up buying just as stocks are about to drop. Dollar-cost averaging can help take the emotion out of investing. It compels you to continue investing the same (or roughly the same) amount regardless of the market's fluctuations, potentially helping you avoid the temptation to time the market.

How can dollar-cost averaging help your investments? ›

Key takeaways

A dollar-cost averaging approach can help take emotions out of investing by encouraging you to commit regular sums of money to the market regardless of fluctuations. The strategy can prove particularly powerful during falling and volatile markets, when you can buy shares at lower prices.

Does dollar-cost averaging work in a recession? ›

The dollar-cost averaging method works best over the long term for investors who do not want to worry about how their investments are performing. If you are going to hold stocks during a recessionary period, the best ones to own are from established, large-cap companies with strong balance sheets and cash flows.

What is the best day of the week to buy stocks? ›

Timing the stock market is difficult, but understanding when to trade stocks can help your portfolio. The best time of day to buy stocks is usually in the morning, shortly after the market opens. Mondays and Fridays tend to be good days to trade stocks, while the middle of the week is less volatile.

What is a downside of the share price dropping? ›

Key Takeaways. When a stock tumbles and an investor loses money, the money doesn't get redistributed to someone else. Drops in account value reflect dwindling investor interest and a change in investor perception of the stock.

Is dollar-cost averaging profitable? ›

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.

Does dollar-cost averaging really work? ›

Dollar cost averaging works because over the long term, asset prices tend to rise. But asset prices do not rise consistently over the near term. Instead, they run to short-term highs and lows that may not follow any predictable pattern.

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.

Is it better to invest monthly or weekly? ›

You just pay more. But, if you invest the same amount of money in a year, there is no difference if you invest $250 a week or $1084 a month.

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