Dollar-Cost Averaging: How Does DCA Work, And Should You Do It?

A brief primer on a popular set-it-and-forget-it investing method

Dollar-cost averaging (DCA) is one of the most important concepts an individual investor can master.

Fortunately, it's also one of the easiest.

The idea of dollar-cost averaging is to invest your dollars in a stock, exchange-traded fund (ETF) or other security in regular, equal portions over time. Sure, you could invest your cash in a single lump sum, but how do you know you're getting the best price? (Remember: The idea is to buy low.)

In the short term, many stock movements can be random, and even the pros are more likely to fail than succeed when trying to precisely time the market.

Dollar-cost averaging doesn't guarantee you the lowest cost basis on your investments. It can, however, produce a lower average cost basis over a longer period of time than lump-sum investing.

And, again, it's easy to do.

How Dollar-Cost Averaging Works

If you have a 401(k) or similar plan where you automatically invest a percentage of every paycheck in a retirement plan, guess what? You are already dollar-cost averaging. That's because every pay period, you're investing the same amount of cash like clockwork.

But say you want to do this in an IRA or brokerage account. Here's an example of how this would work with an individual stock.

You have $10,000 to invest in, say, grocery chain Kroger (KR). You effectively have two options:

  • 1.) Make a lump-sum investment of $10,000. If shares in the supermarket chain decline soon after you make your investment, however, you might kick yourself over your poor timing.
  • 2.) Dollar-cost average, investing the $10,000 gradually and at regular intervals. For instance, you might purchase $833.33 worth of KR stock every month for 12 months. The beauty of dollar-cost averaging is that if Kroger stock does indeed decline over that period of time, you'll buy KR shares at a lower cost. Thus, you'll get more shares for your $833.33, too.

Here's how dollar-cost averaging with KR would've looked across 2019, assuming you had bought at the closing price of each month:

Getty Images

In short, DCA lets an investor automatically buy more shares in a company when they're cheaper, and fewer shares when they're more expensive.

Nothing's a Guarantee, Of Course

As with everything in investing, DCA is not without its detractors. Dollar-cost averaging can underperform lump-sum investing at times.

But while systematic investing does not guarantee a profit or protect against loss, it can lift a psychological brick or two off your shoulders. With DCA, you don't need to agonize over whether you should buy right now, or wait for earnings, or wait for a market dip. You just implement the system and keep yourself updated on the stock over time.

Investors also need to consider whether they have the stomach to keep buying when share prices are falling. Dollar-cost averaging doesn't mean to throw good money after bad if the company's narrative has changed considerably. But it does mean being consistent through short-term ups and downs.

That said, DCA can be a good strategy for long-term investors who just want to set it and forget it.

Most Popular

Tax Wrinkles for Work-at-Home Employees During COVID-19

Tax Wrinkles for Work-at-Home Employees During COVID-19

Are your home office expenses deductible? How does going out of state to work for a while affect your tax picture? There are some interesting wrinkles…
November 9, 2020
Retirement: It All Starts with a Budget
personal finance

Retirement: It All Starts with a Budget

When you’re meeting with your financial planner, do you talk about your budget? If not, you should.
November 10, 2020
Will Joe Biden Raise YOUR Taxes?

Will Joe Biden Raise YOUR Taxes?

During the campaign, Joe Biden promised that he would raise taxes for some people. Will you be one of them?
November 10, 2020


Bonds: 10 Things You Need to Know
Investing for Income

Bonds: 10 Things You Need to Know

Bonds can be more complex than stocks, but it's not hard to become a knowledgeable fixed-income investor.
July 22, 2020
The Best Vanguard Funds for 401(k) Retirement Savers
mutual funds

The Best Vanguard Funds for 401(k) Retirement Savers

Vanguard funds account for a third of the 100 most popular 401(k) retirement products. We rank Vanguard's best actively managed funds, including its t…
November 27, 2020
Is the Stock Market Open on Thanksgiving and Black Friday 2020?

Is the Stock Market Open on Thanksgiving and Black Friday 2020?

The stock market will take a pause on Thanksgiving, but investors will need to pay attention for a few hours on Black Friday.
November 25, 2020
Build a Bond Ladder
Financial Planning

Build a Bond Ladder

Exchange-traded funds give a new twist to an old technique to navigate a tricky market and manage cash flow.
November 23, 2020