Should You Use Dollar-Cost Averaging? - TipRanks.com (2024)

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. So, should you use dollar-cost averaging in your own investments?

Dollar-cost averaging is simple to understand and easy to implement, and chances are you are already applying it with some of your investments. Read on to understand how this strategy works in practice, and determine whether or not it is right for you.

What is Dollar-Cost Averaging?

Dollar-cost averaging is the idea that you will invest the same sum of money into your portfolio at regular intervals. This can be for any investment, though it is usually associated with securities that can have heavy movement, such as stocks, ETFs, or index funds.

In other words, you are focused on the amount you are investing, not the quantity of the security that you are buying. By investing the same amount of money irrespective of price, dollar-cost averaging takes a good chunk of risk out of the equation.

As an example, Dan decides that he wants to purchase $500 worth of Apple (NASDAQ:AAPL) every month, and starts using this strategy in March 2023. He does this the first of every month, so on March 1st, with a share price of $144.72, he is able to purchase 3.46 shares (let us assume that Dan uses a broker that allows him to acquire fractional shares). At the beginning of April, the share price of Apple has risen to $165.50, allowing Dan to purchase 3.02 shares of Apple for the same $500 investment.

Dan purchases $500 of Apple stock every month, regardless of share price, slowly but surely acquiring a larger holding. In essence, Dan is “averaging” out the price at which he is acquiring the asset (hence the name). The TipRanks’ Dollar-Cost Averaging Calculator will allow you to experiment with different publicly-traded securities, investment amounts, and periods of time to better understand how this strategy can work for your desired investment preferences.

What are the Benefits of Dollar-Cost Averaging?

There are two principle benefits of dollar-cost averaging: a reduction of risk and promoting a strategy of making regularly investments.

(1) Reduction of risk: In the aforementioned example with Dan, Apple’s stock had a strong year in 2023, raising the value of his initial investment. Had he decided to go with another stock that did not perform as well throughout 2023, his starting investments would have lost value though he would have been able to acquire more shares as the price dropped.

By averaging out the price of purchase, you are also reducing your risk of market volatility. Markets go up, and markets go down, but Dan will continue to purchase $500 worth of Apple shares. Some months this will purchase more shares, and some months it will be less. Unlike other investors who seek to time the market perfectly, the fluctuations do not influence Dan’s investments. His risk, just like his purchases, averages out over time.

(2) Consistent investing: The best investment practices are the ones that ensure you continue saving and investing (instead of consuming). Budgeting frameworks such as the 50-30-20 rule, whereby you are allocating 50% of your after-tax income to needs, 30% to wants, and 20% to savings and investment, are meant to help individuals save and invest.

Dollar-cost averaging meshes nicely with this strategy, by helping to create the environment where you will be consistently putting money aside for the future.

Anyone who has a 401(k) or makes regular contributions to an Individual Retirement Account (IRA) is essentially partaking in dollar-cost averaging. With every paycheck (or at other regular intervals), you are sending money into your chosen funds. These contributions are being made irrespective of the market’s or fund’s performance, allowing you to steadily grow your retirement savings.

Who Should Use Dollar-Cost Averaging?

Dollar-cost averaging is a useful strategy for those who want to regularly increase their savings, but without the concerns or the hassle that comes along with constantly monitoring the markets.

It is a good strategy for those who have lower risk profiles, as it enables investors to take advantage of the market without having to worry about its regular fluctuations. It follows that individuals using this strategy do not need to stay updated regarding every single dip and bump in the markets, as their purchases, amounts, and timing have already been decided.

Dollar-cost averaging can be a wise approach to follow if you consider yourself a generally risk-averse investor. Pairing this strategy with investing in a mutual fund can provide an even greater level of security, as your fortunes will not be dependent on the performance of a single company but rather spread out over multiple assets and even industries.

Conclusion: Growing Your Savings Through Dollar-Cost Averaging

Dollar-cost averaging is a straightforward approach to growing your wealth. By adhering to this strategy, you will make regular contributions to your investment portfolio without relying on the overall market environment.

It is not geared for those who may try to beat the market by timing their investments. While this approach has the potential to outgain dollar-cost averaging during certain periods of time, it also carries inherent risks and the potential for larger losses.

At the end of the day, the purpose of investing is to create money for future use. Dollar-cost averaging guarantees that a portion of your after-tax income is allocated exactly for this purpose.

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Should You Use Dollar-Cost Averaging? - TipRanks.com (2024)

FAQs

Should You Use Dollar-Cost Averaging? - TipRanks.com? ›

Dollar-cost averaging is a straightforward approach to growing your wealth. By adhering to this strategy, you will make regular contributions to your investment portfolio without relying on the overall market environment. It is not geared for those who may try to beat the market by timing their investments.

Why i don t recommend dollar-cost averaging? ›

Cons of Dollar-Cost Averaging

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.

Does dollar-cost averaging actually work? ›

It's important to note that dollar-cost averaging works well as a method of buying an investment over a specific period of time when the price fluctuates up and down. If the price rises continuously, those using dollar-cost averaging end up buying fewer shares.

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 advantages of dollar-cost averaging responses? ›

It keeps you open to opportunities. Market timing—trying to pinpoint precisely when the market will reach its peak or hit the bottom, and buying and selling accordingly—is almost impossible, even for professional investors. Dollar cost averaging helps ensure that you'll be at the door when opportunity knocks.

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

Why do you think dollar-cost averaging reduces investor regret? ›

Dollar-cost averaging makes it easier to stick to the plan

In hindsight, after the market has recovered, investors often regret not taking advantage of what they now know to be a great buying opportunity.

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.

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.

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.

Is it better to DCA or lump sum? ›

The lump-sum strategy came out on top in each time period. This is because markets generally rise over time. So the DCA investor often bought in at higher average prices. While this data is helpful, many of us do not make decisions based solely on stats and figures.

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 are the 3 key benefits to using dollar-cost averaging? ›

Three benefits of Dollar-Cost Averaging
  • Emotion. The most common error in investing is investing with emotion. ...
  • Long-Term Plan. Dollar-cost averaging provides you with the ability to seed the market with small sums of investments. ...
  • Avoid Market Mistiming. No one can predict where the market is going at any given time.

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 invest monthly or annually? ›

Over shorter timeframes, it tends to make little difference whether you invest a lump sum or split it into regular amounts. In a given year, for instance, it is much closer to 50/50 whether a lump sum at the start works out better than splitting it up over the twelve months.

Is it better to DCA or lump-sum? ›

The lump-sum strategy came out on top in each time period. This is because markets generally rise over time. So the DCA investor often bought in at higher average prices. While this data is helpful, many of us do not make decisions based solely on stats and figures.

Is value averaging better than dollar-cost averaging? ›

Several independent studies have shown that over multiyear periods, value averaging can produce slightly superior returns to dollar-cost averaging, although both will closely resemble market returns over the same period. In dollar-cost averaging (DCA), investors always make the same periodic investment.

Is dollar-cost averaging riskier than lump-sum investing? ›

Dollar-cost averaging may spread the risk of investing. Lump-sum investing gives your investments exposure to the markets sooner. Your emotions can play a role in the strategy you select.

Is dollar-cost averaging better than timing the market? ›

Dollar cost averaging is often considered more suitable for novice investors, as it requires less knowledge and experience to implement. Market timing, however, may be more appropriate for experienced investors who have a deeper understanding of market trends and the ability to analyze and interpret market data.

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