Why Dollar Cost Averaging Works

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There are various investment strategies, but if you’re a newcomer to the world of stocks and funds and not willing to take risks in order to make big bucks, you’re better off sticking to one particular strategy that is tried and tested and earns you bang for buck. Dollar cost averaging (or unit cost averaging depending on your choice of currency) has its share of detractors, but it has proved its worth time and again, especially for people who:

  • Don’t have too much money to invest as a lump sum.
  • Are not investment savvy and don’t know too much about the stock market and its risks and vagaries.
  • Do not want to take too large risks with the stock market.
  • Are looking for a regular investment every month or week or quarter.

For those of you who are not familiar with the strategy, dollar cost averaging is the process of systematically investing in a particular stock or fund by putting in an equal amount of money during a certain time period, say a fortnight, a month or a quarter. In general, the idea is that it helps you beat the odds and come out with a reasonable profit, one that is neither too large nor too small.

The major advantage of dollar cost averaging is that you are buying more shares when the price is low and fewer when the price is high. Since you are investing the same amount during each time period, you don’t have to break your head over how much to invest and how many shares you are going to buy during each investment. And because of this, you are protected from the fickleness of the market.

The detractors of this method hold that transaction costs do tend to add up with each investment and that because the market tends to generally drift upwards over a long term period, you are bound to do better with a lump sum investment or by investing randomly. But, when you are in the strategy for the long haul, say a period of five or more years, dollar cost averaging does work well. It may not offer spectacular returns, but it does make you a decent amount of money even while buffering you from the risks associated with this market.

So if you’re a newcomer to the stock market, go ahead and try dollar cost averaging. You can’t fail with it!

This guest post is contributed by Omar Adams.

Readers: Which would you rather do with $10k? Invest your money all at once, or dollar cost average?

Larry Ludwig

Larry Ludwig was the founder and editor in chief of Investor Junkie. He graduated from Clemson University with a bachelor of science in computers and a minor in business. Back in the ’90s, I helped create some of the first financial websites for firms like Chase, T. Rowe Price, and ING Bank, and later went on to work for Nomura Securities. He’s had a passion for investing since he was 20 years old and has owned multiple businesses for over 20 years. He currently resides in Long Island, New York, with his wife and three children.

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6 Comments

  1. I’m a big DCA fan and have been doing it for 25 years.

    The biggest benefit is that you invest regularly (Pay Yourself First), which is the surest way to accumulate wealth. Few people can afford to invest a big lump sum, but almost anyone can invest a little each month.

    The benefit of Cost Averaging is very real. After both the Dotom Bust and the Subprime Crisis, I lost a lot of money in my portfolio. However, both times, I recovered quickly because I kept investing while the markets were down. It works.

  2. Dollar cost averaging is pretty widespread. People that have a 401k contribute a specified amount on a regular basis. What many fail to realize is that they should hope for stocks to drop so that they are averaging in at low prices. Unfortunately when stocks do take a meaningful drop they reallocate out of stocks. Apparently they prefer to buy in at higher prices.

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