What is Dollar Cost Averaging (DCA)? How Can You Build Your Wealth With This Technique?

“Fear” of losing money and missing out on the correct market timing keeps most people from investing. Dollar-cost averaging, a more cautious strategy than lump sum investing, may better suit the temperament of these wary investors. Moreover, as DCA purchases are spread across time, it reduces the impact of market volatility and absolute risk.

Let’s take a deeper dive into the concept of dollar-cost averaging and how it may aid in the long-term growth of an investor’s portfolio.

What is dollar cost averaging?

• Dollar-cost averaging is a method of investing in which a predetermined amount is invested at fixed intervals to buy a particular stock, mutual fund, or another asset at a constant price. The primary motivation for using this method is to save investors the trouble of continually anticipating market changes and pinpointing the precise optimum moment to acquire an asset.
• The “average” notion behind this method is self-explanatory: you continue to invest the same amount at set intervals regardless of whether the price is low, high, or flat. Because of this, the final result is arithmetically averaged out.
• Most experts agree that dollar-cost averaging is the best strategy for stable and reliable investment development over the long run.

How does dollar cost averaging work? 

• The first step in implementing a dollar-cost-averaging approach is determining the overall amount you want to invest, the amount you wish to contribute at each interval, and the frequency of your payments (weekly, biweekly, or monthly).
• After developing a strategy, the next step is to open a brokerage account and program your investments to run automatically.
• Let’s examine a concrete instance for a clearer picture of how DCA works.
• Let’s say you’ve decided to put $1,500 into XYZ Corporation. Using dollar-cost averaging, you put $150 per month into an investment account to acquire XYZ shares. Your monthly contributions are ‘pre-determined,’ so you may always put the same amount into your investment account regardless of the market, allowing you to buy more or fewer shares in any given month.
• The following is a hypothetical breakdown of how $1,500 may be spent on stocks over ten months.

If you spend $150 every month for ten months, you will have a total of 126.3 shares, as shown.

Dollar-cost averaging vs lump sum investing: Comparing results 

While dollar cost averaging allows contributions to be made periodically, making a single significant commitment is possible whenever funds become available.

Consider the following table to compare the DCA and a lump sum investment in the above scenario.

From the looks of the graph, you dropped $1,500 all at once to purchase 100 shares of XYZ firm.

If you use the DCA method, this example suggests that you will finish owning a more significant number of shares (126.3) than if you had purchased all of the shares at once (100 shares). Consequently, the DCA technique would yield greater financial rewards if XYZ stock had a sustained price increase.

But investing a small amount can only beat out dollar-cost-averaging over time. Since DCA is not foolproof, investing real money at once may be the best option in many practical situations, mainly if it is sizable.

Pros of dollar cost averaging 

• The following are some of the main benefits of dollar-cost averaging that have contributed to its widespread acceptance:
• Due to DCA’s facilitation of low minimum investment requirements, investors need to immediately join the market before they have amassed a sizable quantity. Because of this, this method is particularly well-suited for young investors who still need to amass a large fortune. In addition, a low barrier to entry is also helpful for those who are risk apprehensive and want to put only some of their eggs in one basket.
• A systematic approach to investing, dollar-cost averaging helps you build money over time.
• DCA guarantees consistent investment even in down markets, which often results in exceptional returns in the long run. Although it may seem frightening to put money into the market when everyone else is selling their assets, market cycles have shown that even the most gloomy prices ultimately recover and provide spectacular profits. More importantly, studies conducted by Charles Schwab reveal that investors who stay the course during volatile markets have a higher rate of success than those who attempt to time the market.
• An investor’s emotions may be removed by using dollar-cost averaging. DCA is a dependable method of removing emotions from investing, which may improve trading performance.

Cons of dollar cost averaging

If you’re considering going the DCA route, here are a few things to consider.

• If you make periodic investments, you may incur higher transaction costs.
• Sitting on a significant chunk of money (as in the case of DCA) may not be wise because of the possibility of losing out on profits.
• Stocks that provide dividends should not be valued using DCA.
• To put it simply, DCA is not risk-free. In the past, we discussed the possibility of making costly stock purchases.

Do you think that dollar cost averaging is a good approach for you to use?

Dollar-cost averaging may be advantageous in many situations, but this is not always the case. Whether or not it’s a good fit depends on your individual goals, risk tolerance, and preferences. Investors who “buy the market dip” in the perfect scenario would be more successful than DCA investors. Thus, there is also an element of “luck” or “research,” you might say.

Dollar-cost averaging, however, might be the best option for you if:

• It would help if you avoided constant market monitoring and in-depth market research.
• It would help if you played it conservatively and methodically while investing.
• You are not in. You only have a little money to work with as a new investor.
• Many rushed to make massive progress quickly.