What is Dollar-Cost Averaging? An introduction to DCA

The three videos scheduled for today were going to cover hedge funds. After watching them, however, I've decided they're not necessary for basic financial literacy. Unless I've missed something, hedge funds are targeted primarily at institutional investors. If you want to learn more about them, you can visit the SEC or watch Michael's videos at YouTube:

Instead of covering hedge funds, we'll move on to Michael's discussion of timing investments and dollar-cost averaging:


Timing investments and dollar-cost averaging (5:52)

 

Because the stock market has historically shown strong returns over long periods, we can take advantage of this by ignoring short-term market movement and making regularly scheduled investments, regardless the market's condition. This technique is called “dollar-cost averaging”.

Critics of dollar-cost averaging argue that it provides a lower return than investing a lump sum now. This is true. If you have a choice, you should always invest early instead of waiting to spread the investments over time.

However, dollar-cost averaging is an excellent technique for those who cannot afford to invest a large sum at one time. If you have the choice between saving $4000 to put into your Roth IRA at the end of the year, for example, or paying $333.33 a month, do the latter. Don't bother trying to time the market, but make regular scheduled investments.

(I'll scan and post Michael's chart later. I hadn't intended to post this video today, and so I'm unprepared.)

Next week, Michael's video series winds down as he describes how to put the concepts he's taught us into practice.

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James
James
13 years ago

Note that if you are investing in something requiring a commission (individual stocks, ETFs, etc.) that the commissions will eat into some or most of the gains of dollar-cost averaging, since you’ll be paying that commission twelve times (in the above example) vs. once.

Of course, doing it monthly you are much more likely to actually CONTRIBUTE to your Roth or other investment than if you wait till the end of the year (likely you won’t have $5000 just sitting around…)

Wanda
Wanda
13 years ago

Even if you are contributing $5,000 into your IRA at the beginning of every year, you’re still dollar-cost-averaging… just on an annual basis.

ETF Guy
ETF Guy
13 years ago

I suggest dollar cost averaging to folks that I don’t think have what it takes to ride out a big drop. If there’s any chance that they’ll panic and sell their positions because of a sudden decline, then dollar cost average adds some psychological protection. It eliminates the possibility of having things decline the day after a large amount of cash is invested.

Carter Adler
Carter Adler
13 years ago

You missed one of the key advantages of dollar-cost averaging, from which the name is derived.

By definition, when you are doing a DCA, you invest the same amount each period. What this means in practice is that when your investment is at a lower value, you buy more shares, and when it is at a higher value, you buy fewer shares. As a result, your average price per share is lower than it might otherwise be.

Mr.Batman
Mr.Batman
13 years ago

That is how I invest! How else does a person really invest money anyway. You get paid weekly, you invest weekly (or monthly). No matter what you call it, you’re still DCA.( I don’t know of a person that invest new money on a daily basis!)That isn’t what real life is about. I use DCA and have done pretty well with it in my ETF’s account.I invest money as soon as I get it, so I’m not tempted to spend it.Everybody is DCA”ing

John K
John K
13 years ago

(I am not a financial advisor and this is not professional advice) The dollar cost averaging method is a good way for someone to invest when they cannot invest larger amounts all at one time, but it can also hurt in the long run. If you don’t have time to activly manage your investments and are willing to suffer some returns, then average cost is your way to go. Average cost means half the time you are buying low and half the time you are buying high. The higher the price, the fewer shares you get. In reality, the price… Read more »

CT
CT
13 years ago

First of all, this technique is why Zecco can be such a good deal. You get 40 free trades a month, so you can do up to 40 buys a month on a regular basis. I tend to like another strategy though. I invest around the same amount per month, but I always try to keep the percentages of each of my holdings the same. For example, let’s say one month I have $1000 in stock A, $2000 in stock B, and $4000 in stock C. The next month, those same stocks are worth A:$1500, B:$2000, and C:$3500. If I… Read more »

Jeff
Jeff
13 years ago

Dollar Cost Averaging is just a fancy term, used by people in the industry, to sound smart. It really means nothing.

The stock/fund price is what it is, I don’t care how/when you buy it. You can make money and you can loose money. Bottom Line.

Jeremy
Jeremy
11 years ago

@ John K: Dividends also are a taxable event, so the finance industry is supposed to recommend you wait until dividends to buy. Otherwise, you put in the money you want, immediately get some back (so you have to put it in again) – and have taxes on what could have been a long-term investment. Always buy right after dividends. On DCA, put the numbers in a spreadsheet: say $50 a month at $20, $19, $18, $19, $17, etc. Bounce around a little bit – maybe go down to $12 to match our current economy, then back up to $16.… Read more »

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