What dollar-cost averaging is
Dollar-cost averaging means investing a fixed amount on a regular schedule. Here is how it works, what it does and what it does not do.
Dollar-cost averaging means investing the same amount of money on a regular schedule, no matter what prices are doing. For example, someone might invest $200 on the first day of every month.
How it works
You pick three things:
- An amount. The same dollar figure each time.
- A schedule. Weekly, every two weeks or monthly are common.
- An investment. Often a fund, such as an index fund or an ETF.
Then you invest that amount on schedule, whether the market is up or down.
A simple example
Say you invest $100 each month in a fund.
- Month 1. The price is $10. You buy 10 units.
- Month 2. The price falls to $5. You buy 20 units.
- Month 3. The price rises to $10. You buy 10 units.
You invested $300 and own 40 units. Your average cost per unit is $7.50, even though the price was $10 in two of the three months.
That happens because a fixed amount buys more units when the price is low and fewer when it is high.
These numbers are only an illustration. Real prices rarely move this neatly.
Why people use it
It builds a habit. Investing on a schedule makes saving routine. Many people set it up to happen automatically.
It removes the need to pick a time. Nobody can reliably know the best day to invest. A fixed schedule takes that decision away.
It can reduce regret. Spreading purchases over time means you are less exposed to having put everything in right before a drop.
It fits how many people get paid. Most people earn money every week or month, not in one lump sum. Investing part of each paycheque is a natural form of dollar-cost averaging. Workplace retirement plans often work this way.
What it does not do
Dollar-cost averaging is a method for buying. It is not a guarantee.
- It does not prevent losses. If an investment falls and stays down, you lose money.
- It does not guarantee a profit. The result depends on what the investment does over time.
- It does not choose the investment for you. Investing steadily in something that performs poorly still gives a poor result.
Lump sum vs spreading it out
Sometimes a person has a large amount to invest at once, such as an inheritance or a bonus. They can invest it all now, which is called a lump sum, or spread it over months using dollar-cost averaging.
Each approach has trade-offs.
- Investing all at once puts the full amount to work right away. If prices rise, more money benefits from the rise. If prices fall soon after, the whole amount takes the loss.
- Spreading it out limits the effect of a sharp drop just after investing. But the money waiting to be invested may miss gains if prices rise in the meantime.
Neither approach wins every time. The outcome depends on what markets do, which nobody knows in advance. The choice often comes down to a person's comfort with short-term swings. A fee-only financial planner can help with a decision that fits your situation.
Costs to watch
Frequent small purchases can add up if your broker charges a fee for each trade. Many brokers now offer free trades on some products, but not all do. Some funds and plans offer automatic purchases at no extra cost. Check the fee schedule before setting a plan.
Fund fees matter too, because they apply to everything you invest every year. See how compound growth works.
Sticking with it
The method only works as designed if you keep investing when prices fall. That is when a fixed amount buys the most units. It is also when many people feel like stopping.
Market drops are a normal part of investing. You can read about them in bull market, bear market and correction.
The short version
- Dollar-cost averaging means investing a fixed amount on a set schedule.
- A fixed amount buys more units when prices are low and fewer when high.
- It builds a habit and removes the need to time the market.
- It does not prevent losses or guarantee a profit.
- Lump sum and gradual investing each have trade-offs.
This is general information, not investment advice.
Updated