What is dollar-cost averaging and how does it work?
This slow and steady investment approach could help you manage market volatility and get more value for your money. Here's how it works.
You may have heard of an investment strategy called dollar-cost averaging and wondered, "What's that?" In reality, if you contribute a set amount of money to your retirement account every month, you're already using dollar-cost averaging. It's a strategy that has many benefits, especially during periods of volatility.
Simply put, dollar-cost averaging is the practice of investing a fixed amount of money at regular intervals, regardless of current market conditions. Over time, this consistent approach can help limit the effects of the market's peaks and valleys, reduce the average price you pay for shares and improve your portfolio's potential for long-term growth.
Just starting out?
Instead of waiting for "the perfect moment," when you have more money or prices are lower, try this slow and steady, disciplined approach to building your portfolio.
Four reasons to consider dollar-cost averaging
1. It's convenient.
"One of the key benefits of dollar-cost averaging is that it makes investing a regular part of your financial life," says Kirsten Cabacungan, an investment strategist with the Chief Investment Office (CIO) for Merrill and Bank of America Private Bank. With a plan in place to invest a certain amount regularly — whether it's weekly, monthly or at some other interval — it takes the guesswork out of deciding when to invest and removes some of the temptation to spend the money elsewhere.
2. It's cost-effective.
As share prices fluctuate, investing fixed amounts — whether in shares of an individual stock or an index or mutual fund — enables you to potentially buy more shares when prices are lower and fewer when prices are high. As the chart below illustrates, dollar-cost averaging not only creates portfolio momentum by potentially giving you more total shares of a stock or a fund; it can also potentially lower your average cost over time.
 Month |
 Amount invested |
 Price per share |
 Shares purchased |
| |
 Nick |
 Karsen |
Nick |
Karsen |
Nick |
Karsen |
| January |
$2,000 |
$500 |
$40 |
$40 |
50 |
12.5 |
| February |
|
$500 |
|
$42 |
|
11.9 |
| March |
|
$500 |
|
$38 |
|
13.1 |
| April |
|
$500 |
|
$35 |
|
14.2 |
| Total |
$2,000 |
$2,000 |
$40 |
$38.75 |
50 |
51.7 |
| Hypothetical results are for illustrative purposes only. |
In the hypothetical example above, Karsen purchased her shares at an average cost of $38.75 compared to the $40 per share that Nick spent. Of course if Nick had invested the full $2,000 in April when the price hit a low for the year of $35 per share, instead of paying $40 per share in January he would have come out ahead. But since there's no way to predict such swings, dollar-cost averaging removes the stress of trying to guess the best time to buy.
3. It can help you avoid costly mistakes during volatility.
Sudden market shifts can prompt hasty decisions to sell when prices are falling. Having a disciplined schedule of investing regular amounts over time makes it more likely that you'll stay in the market and focused on your long-term goals. "Volatility is a normal and even integral part of investing," Cabacungan says. "Dollar-cost averaging could help you filter the noise and view periods of weakness as buying opportunities."
Worried about periodic volatility?
Dollar-cost averaging can help you resist impulse moves and take advantage of price fluctuations, potentially smoothing the ride for your portfolio in the long run.
4. It's a constructive way to put more cash to work.
Cash is essential for meeting expenses and emergencies without having to sell illiquid investments. "But maintaining too much of a cash cushion could rob you of the long-term growth potential that other investments like stocks can offer," Cabacungan says. An advisor, if you have one, can help you find a comfortable cadence and amount to invest that doesn't conflict with your other financial needs.
Sitting on extra cash or recently received a windfall?
Dollar-cost averaging gives you an easy, cost-effective way to invest that cash for potential higher returns in the stock and bond markets.
How to automate the process
While you can implement dollar-cost averaging by making regular investments on your own, an automated approach may be easier and more consistent. Here's how to get started:
- Figure out how much you want to contribute.
- Determine the frequency — weekly, monthly or otherwise.
- Arrange to have that amount transferred from your checking or other cash management account into an investment account — an IRA or brokerage account, for instance — and invested according to your preferred asset allocation.
Keep in mind that for all its benefits, dollar-cost averaging is not a panacea. There's no guarantee that you'll achieve the returns you seek or prevent losses. Dollar-cost averaging is just a tool to help you put into action the important decisions you've made about which assets to invest in, how to maintain a balanced portfolio and when to rebalance. "You don't just set dollar-cost averaging and forget it," Cabacungan advises. Over time you may want to adjust the amount you invest, as well as the frequency, just as you periodically review and adjust your asset allocation and the assets you invest in.
A program of regular investment cannot assure a profit or protect against a loss.
A continuous or periodic investment plan involves investment in shares over time regardless of fluctuating price levels.
You should consider your financial ability to continue purchasing shares during periods of low price levels.
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