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Dollar Cost Averaging: What It Is & How It Works

Dollar Cost Averaging: What It Is & How It Works

Dollar-cost averaging, or DCA, is an investment strategy that tries to minimize your risks by making multiple purchases of an asset over a period of time, realizing several different entry prices.

By spreading out the purchase of a security over several smaller purchases, the DCA strategy makes periodic deposits which combine to form an "average" price. The investor would add the investment purchase prices, then divide the sum by the amount of purchases made.

Let's say you've identified an investment and noticed the stock price tends to move up and down a lot. You're not sure if the price you'd pay now is the best you'll see or if it will drop in the days and weeks to come... you could instead buy $100 per month. Reviewing the purchases after five months, you see that you'd purchased units at $50, $49, $48, $47, and $51.

The total number of units received from the five $100 outlays would have been approximately 10.21 resulting in an average cost of $48.97.

When you dollar-cost average, you buy more shares of an investment when the share price is low and fewer shares when the share price is high. This can result in paying a lower average price per share over time. It's worth noting that dollar-cost averaging doesn't always result in a lower average cost.

The basic steps for an investor to set up DCA are to choose the investment, determine a dollar amount to invest, choose an investment frequency, and decide if they want to make manual purchases or set up automated deposits.

In closing, any investment strategy is only as good as the stocks you pick. Dollar-cost averaging can help ease apprehension and is better than trying to time the markets, but it is no substitute for finding quality companies to invest in.


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