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Dollar-Cost Averaging: What Investing a Fixed Amount on a Schedule Does

Dollar-cost averaging invests the same amount at regular intervals. Why it lowers your average cost, what it cannot protect against, and lump sum versus DCA.

By Published 3 min read

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Key takeaways

  • Dollar-cost averaging means investing equal amounts at regular intervals, regardless of whether the market is up or down.
  • A fixed amount buys more shares when prices are low and fewer when they are high, so the average cost per share is the harmonic mean of the prices, which is lower than their simple average.
  • It does not prevent losses: if prices keep falling, a dollar-cost averaging investor still loses money.
  • Investing regular income as it arrives is different from spreading out a lump sum; Vanguard's modelling found investing a windfall at once did better about two-thirds of the time.
  • Wikipedia counts discipline as a major advantage: once the amount and frequency are set, no further timing decisions are needed.

Putting a slice of each paycheck into a retirement plan or a brokerage account, month after month, has a name: dollar-cost averaging (DCA). Investor.gov defines it as investing your money in equal portions, at regular intervals, regardless of the ups and downs in the market. The idea is simple, and Wikipedia notes that the term is often confused with a different strategy, which this guide separates out.

How a fixed amount buys more when prices fall

Because the amount is fixed, the number of shares it buys varies with the price. Here is $100 a month for four months:

Month Price per share Shares bought with $100
1 $10 10.0
2 $8 12.5
3 $5 20.0
4 $10 10.0
Total 52.5 shares for $400

Average cost per share: $400 ÷ 52.5 ≈ $7.62. The simple average of the four prices is $8.25.

Compare buying a fixed 10 shares each month instead: 40 shares cost $100 + $80 + $50 + $100 = $330, an average of $8.25 per share. DCA's average is lower because the cheap month bought the most shares.

Why the average comes out lower

Wikipedia's article on dollar-cost averaging explains the maths: with equal amounts invested, your average cost per share is the harmonic mean of the purchase prices, and the harmonic mean is never higher than the ordinary arithmetic mean. In the example, the harmonic mean is 4 ÷ (1/10 + 1/8 + 1/5 + 1/10) ≈ $7.62. The more prices vary, the bigger the gap.

That is the precise sense of Investor.gov's line that you buy more of an investment when its price is low and less when its price is high.

What dollar-cost averaging cannot do

DCA does not stop you losing money. Suppose the price falls every month instead:

Month Price Shares bought with $100
1 $10 10.00
2 $8 12.50
3 $6 16.67
4 $4 25.00

You own about 64.17 shares at an average cost of about $6.23, which is better than the $7 simple average of the prices. But at the final $4 price they are worth about $256.67, against $400 invested. A lower average cost is not the same as a gain. Investor.gov describes DCA as something that can help you manage risk, not as a way to avoid it; risk tolerance covers how much of that risk suits you.

Regular income versus a lump sum

Wikipedia draws a distinction that, it says, much recent debate about DCA confuses:

  • DCA from regular income. You invest money as you earn it, as with payroll deductions into a workplace plan. There is no lump sum waiting, so there is no alternative of investing it all earlier.
  • Spreading out a windfall. You already have a large sum, such as an inheritance, and choose to invest it in stages. Vanguard calls this a systematic implementation plan.

For the second case, Wikipedia reports that Vanguard's historical modelling found investing a windfall immediately outperformed staged investing about two-thirds of the time. That is expected if markets tend to rise: waiting means buying later at prices expected to be higher. The case for staging is behavioural: it reduces the regret of investing everything just before a fall, and it may help someone invest at all who otherwise would not.

Costs, frequency and automation

Transaction costs. Wikipedia gives an example: with a $20 fee per purchase and $500 invested every two weeks, the fee is 4% of each purchase, far more than the expected return for those two weeks. Where fees apply, larger and less frequent purchases can be cheaper. Fees vary by broker, so check yours.

Fractional shares. Dollar amounts only work cleanly if you can buy part of a share; see fractional shares.

Automation. Investor.gov's building-wealth guidance calls consistent and regular investing a great long-term strategy and suggests setting up automatic contributions where you can, a set-it-and-forget-it approach that cuts down on decision-making. It also suggests taking full advantage of any employer matching funds in a 401(k).

Diversified funds are a common vehicle for regular contributions; index funds explained covers them, and compound interest explained shows how regular contributions build up over time. To see how prices and average costs interact, Learn to Trade Stocks Beginner, one of our education apps, lets you practise repeated purchases with virtual money, and a trading journal helps you record each one. The investing basics hub lists the related guides.

Good to know

Frequently asked questions

What is dollar-cost averaging?
Investing the same amount of money at regular intervals, such as $100 a month, whatever the market is doing. Investor.gov explains that this means buying more of an investment when its price is low and less when its price is high.
Does dollar-cost averaging guarantee a profit?
No. It lowers your average cost compared with buying a fixed number of shares, but if the investment's price keeps falling, the total is still worth less than you put in. It is a way of investing, not protection against loss.
Is a lump sum better than dollar-cost averaging?
For a windfall you already have, historical modelling by Vanguard, as summarised by Wikipedia, found investing it immediately did better about two-thirds of the time, because markets have tended to rise. Spreading it out reduces the regret of investing just before a fall, at an expected cost.
How often should I invest?
Wikipedia notes that purchases can be made in line with regular income, for example an automatic investment each payday. If each purchase carries a fixed fee, very small and frequent purchases can cost more than they are expected to earn, so less frequent, larger contributions may be cheaper.

Sources

  1. Dollar Cost Averaging (glossary) (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
  2. Ten Building Blocks to Building Wealth (opens in a new tab)Investor.gov, U.S. Securities and Exchange Commission — accessed
  3. Dollar-cost averaging (opens in a new tab)Wikipedia — accessed

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