Pros and Cons of Dollar Cost Averaging - Experian (2024)

In this article:

  • What Is Dollar Cost Averaging?
  • Pros of Dollar Cost Averaging
  • Cons of Dollar Cost Averaging
  • Is Dollar Cost Averaging Right for You?

Dollar cost averaging is an investment strategy that involves investing the same amount of money at regular intervals, typically monthly. It can help reduce your exposure to certain risks, but there are also some potential downsides to consider, especially if it's your only approach.

If you're currently dollar cost averaging with your portfolio or you're considering it, here's what you should keep in mind.

What Is Dollar Cost Averaging?

Dollar cost averaging spreads out your investment in a particular stock, fund or other security over time instead of with a lump sum.

For example, let's say you're investing in a target-date fund for retirement—the fund's manager will adjust the fund's holdings over time based on your expected retirement date. With a dollar cost averaging approach, you invest $400 per month, regardless of the current share price of the fund.

Here's a quick summary of what the approach might look like over the course of six months:

Dollar Cost Averaging in a Target-Date Fund
Month Investment Share Price Shares Purchased
1 $400 $40 10
2 $400 $37 10.81
3 $400 $41 9.76
4 $400 $39 10.26
5 $400 $46 8.7
6 $400 $41 9.76

Over the six-month period, you've invested $2,400. While the price of the fund fluctuated over time, including one significant jump, your average cost basis per share is $40.67, and you own 59.29 shares.

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Pros of Dollar Cost Averaging

There are some significant advantages to using dollar cost averaging, especially if you can't afford to make a lump-sum investment from the start.

Helps Reduce the Impact of Price Volatility

The stock market and other investments can experience significant price fluctuations in the short term. But if you contribute the same amount to your portfolio each month, you don't have to worry about bad timing.

If a stock or fund price increases one month, you'll buy fewer shares, and your cost per share will go up. But if it drops the next month, you'll end up with more shares and a slightly lower average cost per share.

Takes Emotion Out of the Equation

Volatility in the stock market can trigger a variety of emotions, ranging from excitement to panic.

If you're concerned about making impulsive decisions about your portfolio, dollar cost averaging eliminates that problem by putting the same amount into the investment regardless of how wildly the price swings in either direction.

Helps Build Wealth Over Time

If you're just getting started with investing or you don't have a lot of extra cash, you may wonder whether it's worth it. But you don't need a lot of money to start building wealth. In fact, many online brokers offer fractional shares of stocks and exchange-traded funds (ETFs) starting at $1.

With a dollar cost averaging approach, you decide how much you can afford to invest each month and set up automatic transfers to make the process more convenient.

Cons of Dollar Cost Averaging

While there are some clear advantages with dollar cost averaging, there are also some potential pitfalls to watch out for.

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. If you aren't careful, it could even result in a portfolio that isn't well-diversified.

In other words, dollar cost averaging on its own may not be enough to help you minimize your exposure to risk and accomplish your financial goals.

The Market Rises Over Time

While the market can experience a lot of volatility in the short term, it tends to rise 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. In the example above, for instance, you purchased 59.29 shares over a six-month period. But if you made the $2,400 investment upfront, you'd end up with 60 shares.

It Could Give You a False Sense of Security

While dollar cost averaging can be a great way to ensure that you're investing regularly, it can be easy to get complacent about your investment strategy. The right approach for you may change as the markets, economic environment and your personal financial situation fluctuate over time.

If you're not constantly evaluating and adjusting your investment strategy, your portfolio may not perform over time in the ways you need it to.

Is Dollar Cost Averaging Right for You?

As you consider whether dollar cost averaging is a good investment approach for your portfolio, here are some factors to keep in mind:

  • Your ability to invest: If you have a 401(k), dollar cost averaging generally makes sense because you're investing money as you earn it. But if you have a large amount of money you can put in an individual retirement account (IRA) or brokerage account right now, you may want to consider a lump-sum investment instead.
  • Your risk tolerance: If the prospect of price fluctuations stresses you out, dollar cost averaging can be a great way to reduce or eliminate the impact of emotions on your investment decisions. If you're not bothered by volatility, you may consider other investment strategies.
  • Your goals: Dollar cost averaging generally only benefits you if you're holding on to your investment for the long term. If you're trading for short-term gains, dollar cost averaging may not make a lot of sense.

The Bottom Line

Dollar cost averaging can be a great way to invest for the long term, particularly for retirement. Before you engage in the strategy, however, consider both the benefits and drawbacks and research other investment strategies to find the best approach for your portfolio.

You may also consider consulting a financial advisor who can provide expert advice and personalized guidance for your situation and goals.

Pros and Cons of Dollar Cost Averaging - Experian (2024)

FAQs

Pros and Cons of Dollar Cost Averaging - Experian? ›

Quick Answer

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

Dollar-cost averaging is the practice of investing a consistent dollar amount in the same investment on a regular basis. The dollar-cost averaging method reduces investment risk, but it is less likely to result in outsized returns.

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.

What is downside averaging? ›

As an investment strategy, averaging down involves investing additional amounts in a financial instrument or asset if it declines significantly in price after the original investment is made. While this can bring down the average cost of the instrument or asset, it may not lead to great returns.

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 cons of 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 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 is the success rate of dollar cost averaging? ›

Reviewing the table, since 1926, the odds of a six-month DCA strategy producing more favorable results is only 36%, and the average opportunity cost for a 6-month period is 1.8%. In the last decade, the odds of DCA success are only 21%, with an expected cost of 2.7% for the period.

How long should you do dollar cost averaging? ›

Follow a Plan

If you want to dollar cost average, come up with a plan, put it in writing and stick to it. For example, you may decide to dollar cost average over 12 months. You're going to take one-12th of your money and invest it in each of the next 12 months. Put the plan in writing and then do it no matter what.

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 are the 2 drawbacks to dollar-cost averaging? ›

Pros and cons of dollar-cost averaging
  • Dollar-cost averaging can help you manage risk.
  • This strategy involves making regular investments with the same or similar amount of money each time.
  • It does not prevent losses, and it may lead to forgoing some return potential.

Why is averaging down good? ›

Pros of averaging down

Increased potential gains: Value investors have long known that buying the dip can yield increased potential for gains, given enough time. By doubling down and increasing your exposure, you also raise your potential profit if the price rebounds.

Is averaging down good or bad? ›

When Is Averaging Down a Good Idea? Averaging down works best when you are confident that an investment is a long-run winner. As such, buying the dips will have you accumulating your position at progressively better prices, making your ultimate profit potential greater.

What is dollar-cost averaging Warren Buffett? ›

“If you like spending six to eight hours per week working on investments, do it. If you don't, then dollar-cost average into index funds.” Buffett has long advised most investors to use index funds to invest in the market, rather than trying to pick individual stocks.

Is dollar-cost averaging good for retirement? ›

Dollar-cost averaging offers the greatest benefit to investors who have a long-term investment horizon and can afford to be patient. Especially if they started such a discipline early on in life. If you don't have a long-term investment horizon, it may not be the best way for you to invest.

Should I dollar-cost average if I have a lump sum? ›

You may be thinking: What if I invest this huge sum of money at once and the market takes a downturn soon after? What happens to my returns then? If that's your mindset, dollar-cost averaging may be the strategy for you. In other words, you don't want to have any regrets and you want to minimize the downside risk.

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 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.

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.

Why is dollar-cost averaging better than lump sum? ›

Lump-sum investing may generate slightly higher annualized returns than dollar-cost averaging as a general rule. However, dollar-cost averaging reduces initial timing risk, which may appeal to investors seeking to minimize potential short-term losses and 'regret risk'.

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