Definition

Dollar Cost Averaging

What is Dollar Cost Averaging (DCA)?

Dollar cost averaging refers to a strategy that is used by the investors to manage the risk of price when he has made an investment in stocks or mutual funds. It is an investment strategy by which investors divide the total amount of money that they want to invest in purchasing small quantities of a particular asset over a period of time at uniform intervals.

The investor prefers to invest with dollar cost averaging rather than investing the total amount in a specific asset at a time or with a single purchase to decrease the impact of inconsistency on the overall purchase of an investor. This investment strategy reduces the price risk for an investor that is he/she may have to pay more for a particular investment at a single time before the fall in market prices.

Market prices don’t only fluctuate in one way so by dividing the purchase and making investments in multiple stocks or mutual funds, an investor increase his chances of paying a lower average price in time. Additionally, dollar cost averaging helps an investor to get his invested money to work on a stable basis, as it is the main factor for any long-term investment growth.

 

Summary
  • Dollar-cost averaging is an investment strategy by which investors divide the total amount of money that they want to invest in purchasing small quantities of a particular asset.
  • The investor puts the same amount of money every time, despite the price of an asset with the dollar-cost averaging method.
  • Dollar Cost Averaging helps an investor to get his invested money to work on a stable basis, as it is the main factor for any long-term investment growth.

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Understanding Dollar Cost Averaging (DCA)

Dollar-cost averaging is a process or strategy of an investment through which an investor invests by dividing the total money to be invested in a specific asset over stable intervals of time. Investors can make the investments by opting shares to purchase shares of that specific asset once a week, per quarter, per month or as per the schedule of any other investment. Dollar cost averaging helps an investor to make investment by lowering the amount to be invested and reducing the risk as an investor make the investments with small amount of money with regular intervals instead of making investment at one price in a single time purchase. Over the long period, the dollar cost averaging may help an investor to lower its investment cost and increase its returns.

The investor invests the same amount of money every time, despite the price of an asset with the dollar-cost averaging method. The aim of dollar-cost averaging is to decrease the impact of market uncertainty and volatility. With this investment strategy, an investor can purchase more shares per dollar in the situation of fall (down) in market, and in case of rise (up) an invest can purchaser fewer shares with the same dollars. Investors use dollar-cost averaging as a gauge to generate savings and wealth over a long time. Investors also use the strategy to neutralize short-term fluctuations in the equity market.

For instance, 401(k) plans, the dollar cost averaging is used in 401(k) plans, according to the plan consistent purchases are made despite the price of a given asset. 401(k) plans refers to an investment plan by which an employee can choose a pre-determined amount of money from its salary for making the investment in mutual or index funds. Dollar-cost averaging is considered as one of the best strategies for new investors who just start to invest and to trade exchange traded funds (ETFs).

Frequently Asked Questions

How Does Dollar Cost Averaging Work?

Dollar cost averaging is an investment strategy which takes out the emotion from an investment through buying the consistent small amount of money in a given asset on a regular period. This means an investor purchase less shares when market prices are up and more when prices are down. For example, an investor has a total of US $600 to invest every month. Investors choose to invest their money to purchase an S&P 500 index fund and the current trading price of the index is US $50 per share. Initially, an investor purchases 12 shares of an S&P 500 index fund. But if the price of the S&P 500 index fund will increase to US $60 per share, investor would purchase 10 shares with the US $600. Whereas, if the market price will fall to US $40 per share, investor can buy 15 shares of S&P 500 index funds with the investment of US $600.

What is the significance of Dollar Cost Averaging?

Dollar Cost Averaging is an investment strategy that helps new investors or people who want to start investing and don’t have a lump sum amount to start with. With the Dollar Cost Averaging, investors with low amount of money can also invest by planning a budget with a specific percentage of their income every month. Dollar Cost Averaging is one of the best options for these slow-and-steady investors as they only need to made monthly contributions from their salary. Even dollar-cost averaging is a great choice for those investors too who have a lump sum to invest at the times of high market volatility.

Dollar cost averaging helps to reduce the price risk for an investor and also fear of investing as one of the biggest advantages of dollar-cost averaging is that it spreads the risk of overall return.