Dollar-Cost Averaging (DCA) Definition - Investopedia

Dollar-cost averaging (DCA) is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target ... TableofContents Expand TableofContents Dollar-CostAveraging(DCA) UnderstandingDCA SpecialConsiderations Example Dollar-CostAveragingFAQs Investing InvestingEssentials WhatIsDollar-CostAveraging(DCA)? Dollar-costaveraging(DCA)isaninvestmentstrategyinwhichaninvestordividesupthetotalamounttobeinvestedacrossperiodicpurchasesofatargetassetinanefforttoreducetheimpactofvolatilityontheoverallpurchase.Thepurchasesoccurregardlessoftheasset'spriceandatregularintervals. Ineffect,thisstrategyremovesmuchofthedetailedworkofattemptingtotimethemarketinordertomakepurchasesofequitiesatthebestprices.Dollar-costaveragingisalsoknownastheconstantdollarplan. KeyTakeaways Dollar-costaveragingreferstothepracticeofsystematicallyinvestingequalamounts,spacedoutoverregularintervals,regardlessofprice.Thegoalofdollar-costaveragingistoreducetheoverallimpactofvolatilityonthepriceofthetargetasset;asthepricewilllikelyvaryeachtimeoneoftheperiodicinvestmentsismade,theinvestmentisnotashighlysubjecttovolatility.Dollar-costaveragingaimstoavoidmakingthemistakeofmakingonelump-suminvestmentthatispoorlytimedwithregardtoassetpricing. 1:18 DollarCostAveraging UnderstandingDollar-CostAveraging(DCA) Dollar-costaveragingisatoolaninvestorcanusetobuildsavingsandwealthoveralongperiod.Itisalsoawayforaninvestortoneutralizeshort-termvolatilityinthebroaderequitymarket.Aprimeexampleofdollar-costaveragingisitsusein401(k)plans,inwhichregularpurchasesaremaderegardlessofthepriceofanygivenequitywithintheaccount. Ina401(k)plan,anemployeecanselectapredeterminedamountoftheirsalarythattheywishtoinvestinamenuofmutualorindexfunds.Whenanemployeereceivestheirpay,theamounttheemployeehaschosentocontributetothe401(k)isinvestedintheirinvestmentchoices. Dollar-costaveragingcanalsobeusedoutsideof401(k)plans,suchasmutualorindexfundaccounts.Althoughit'soneofthemorebasictechniques,dollar-costaveragingisstilloneofthebeststrategiesforbeginninginvestorslookingtotradeETFs. Additionally,manydividendreinvestmentplansallowinvestorstodollar-costaveragebymakingcontributionsregularly. SpecialConsiderations Itisimportanttonotethatdollar-costaveragingworksoutfavorablyonlyiftheassetrisesinvalueovertheperiodoftimeinquestion.Dollar-costaveragingdoesimprovetheperformanceofaninvestmentovertime,butonlyiftheinvestmentincreasesinprice.Thestrategycannotprotecttheinvestoragainsttheriskofdecliningmarketprices. Thegeneralideaofthestrategyassumesthatpriceswill,eventually,alwaysrise.Usingthisstrategyonanindividualstockwithoutknowingaboutthecompany'sdetailscouldprovedangerousbecausethestrategymayencourageaninvestortocontinuebuyingmorestockatatimewhentheyshouldsimplyexittheposition.Forless-informedinvestors,thestrategyisfarlessriskyonindexfundsthanonindividualstocks. Investorswhouseadollar-costaveragingstrategywillgenerallylowertheircostbasisinaninvestmentovertime.Thelowercostbasiswillleadtolessofalossoninvestmentsthatdeclineinpriceandgenerategreatergainsoninvestmentsthatincreaseinprice. ExampleofDollar-CostAveraging(DCA) JoeworksatABCCorp.andhasa401(k)plan.Hereceivesapaycheckof$1,000everytwoweeks.Joedecidestoallocate10%or$100ofhispaytohisemployer’splan.Hechoosestocontribute50%ofhisallocationtoaLargeCapMutualFundand50%toanS&P500indexfund.Everytwoweeks10%,or$100,ofJoe’spre-taxpaywillbuy$50worthofeachofthesetwofundsregardlessofthefund'sprice. ThetablebelowshowshalfofJoe's$100contributionstotheS&P500indexfundover10payperiods.Throughout10paychecks,Joeinvestedatotalof$500,or$50perweek;however,becausethepriceofthefundincreasedanddecreasedoverseveralweeks,Joe’saveragepricecameto$10.48.Theaveragewashigherthanhisinitialpurchase,butitwaslowerthanthefund’shighestprices.ThisallowedJoetotakeadvantageofthefluctuationsofthemarketastheindexfundincreasedanddecreasedinvalue. ImagebySabrinaJiang©Investopedia 2020 IsDollar-CostAveragingBetterThanBuyingtheDip? Dollar-costaveragingcanbebetterthanbuyingthedipbecauseifyouareinvestingafixedamountconsistentlythenyouwillhavemoreexposuretodipswhentheyhappenratherthantrackingforadip.Additionally,thefixedamountwillmeanthatyouwillendupbuyingmoreshareswhenthepriceislowerthanwhenitishigher. WhyDoSomeInvestorsUseDollar-CostAveraging? Thekeyadvantageofdollar-costaveragingisthatitreducestheeffectsofinvestorpsychologyandmarkettimingontheirportfolio.Bycommittingtoadollar-costaveragingapproach,investorsavoidtheriskthattheywillmakecounter-productivedecisionsoutofgreedorfear,suchasbuyingmorewhenpricesarerisingorpanic-sellingwhenpricesdecline.Instead,dollar-costaveragingforcesinvestorstofocusoncontributingasetamountofmoneyeachperiodwhileignoringthepriceofeachindividualpurchase. WhatIsanExampleofDollar-CostAveraging? Anexampleofadollar-costaveragingapproachwouldbeinvesting$500permonthinanindexfundthattrackstheperformanceofabroadmarketindex,suchastheS&P500.Insomemonths,theindexwillbepricedhigh,meaningfewershareswouldbepurchasedforthe$500investment.Inothermonths,whentheindexislow,$500wouldpurchaseagreaternumberofshares.Inthelongrun,however,investorswhouseadollar-costaveragingstrategyarebettingthatthesimplicityofthestrategy,combinedwiththefactthatitprotectsthemfromthetemptationofbuyinghighandsellinglow,willultimatelyleadtobetterresultsthantryingtotimethemarketoneachpurchase. CompareAccounts AdvertiserDisclosure × TheoffersthatappearinthistablearefrompartnershipsfromwhichInvestopediareceivescompensation.Thiscompensationmayimpacthowandwherelistingsappear.Investopediadoesnotincludealloffersavailableinthemarketplace. Provider Name Description RelatedTerms WhatIsValueAveraginginInvesting? Valueaveragingisaninvestingstrategythatworkslikedollar-costaveragingbutdiffersinitsapproachtotheamountofeachmonthlycontribution. more WhatDoesAverageUpMeaninInvesting? Averageupistheprocessofbuyingadditionalsharesinastockthataninvestoralreadyowns,atahigherprice. more DoesYourSIPDRIP?UsingSystematicInvestment/DividendReinvestmentPlans Asystematicinvestmentplaninvolvesputtingaconsistentsumofmoneyintoaninvestmentonaregularbasistotakeadvantageofdollar-costaveraging. more Exchange-TradedFund(ETF) Anexchange-tradedfund(ETF)isabasketofsecuritiesthattracksanunderlyingindex.ETFscancontaininvestmentssuchasstocksandbonds. more WhatAreMutualFundsandHowDoTheyWork? Amutualfundisaninvestmentvehicleconsistingofaportfolioofstocks,bonds,orothersecurities,overseenbyaprofessionalmoneymanager. more AccumulationPlan Accumulationplanshelpaninvestorincreasethevalueofaportfolio.Readhowmutualfundinvestorsuseaccumulationplanstobuildretirementnesteggs. more PartnerLinks RelatedArticles PortfolioConstruction 7SimpleStrategiesforGrowingYourPortfolio RothIRA ThisIsHowMuchYouCanContributetoYourIRA TradingPsychology HowtoAvoidEmotionalInvesting InvestingEssentials WaystoSurviveAMarketDownturn 401(k) IndexFundsvs.Target-DateFunds:What'stheDifference? Investing InvestmentStrategiestoLearnBeforeTrading