Dollar-Cost Averaging: Pros, Cons and When To Use This Investment Strategy

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“Buy low, sell high” is common advice among investors — but timing the market can be a full-time job. No one knows what the market is going to do from one hour or one day to the next, and investors can lose a lot of time, energy and money trying to guess. That’s where dollar-cost averaging comes in.

What Is Dollar-Cost Averaging?

Dollar-cost averaging is when you dedicate a consistent amount of money toward your investments on a regular basis. When you do this, you sometimes buy low and other times, at a high. The idea is that your average price point equalizes over time.

The most common example of dollar-cost averaging is a 401(k) plan. When you open a 401(k), you allocate a percentage of your income to invest in the plan. Each of your paychecks reflects the same deduction — for example, 5%. Each month, those funds buy shares of the securities you’ve selected for your 401(k), which are usually index funds, mutual funds, ETFs or some combination. Your 5% will get you a different amount of shares based on how the market is doing that month.

Perhaps even more importantly, dollar-cost averaging requires you to continually invest in the market over the long run. This may be the best single investing tip there is. As famed billionaire investor Warren Buffett has famously said to keep investing “through thick and thin, and especially through thin.”

How Dollar-Cost Averaging Works: Crunching the Numbers

As an investor, you want your money to go as far as possible. For example, let’s say you have $600 to invest. You’ve done your research and decided on an investment, such as a balanced mutual fund with a strong history of solid returns and a low expense ratio.

The amount of money you’re going to put into that fund — $600 — will not change, but the price per share of your investment of choice will as the market moves up and down. These fluctuations mean that your $600 will purchase fewer shares if you buy when your chosen fund is at a higher price, or it will buy more shares if you purchase when the fund’s price is lower.

Here’s a look at how your purchases might break down over the course of a year: 

Since the share price varied throughout the year, you were able to buy more shares some months and fewer shares in others.

If you had spent your entire $600 when the share price was at its lowest — $7 — you would have purchased 85.71 shares.

If you had spent your entire $600 when the share price was at its highest — $13 — you would have purchased 46.15 shares.

By dollar-cost averaging, or making a consistent investment of $50 each month, you would have ended up with 64.61 shares. That’s near the middle point between buying low and buying high. You can feel confident that you made your $600 stretch as far as possible without having to be glued to daily market news, vigilantly watching for ups and downs.

Who Should Consider Dollar-Cost Averaging?

Anyone can use dollar-cost averaging to try and grow their wealth, but it can be a particularly good fit for the following individuals.

Investors Tempted To Try For a Quick Buck

If the desire to hustle runs through your veins, then you are vulnerable to hasty decision-making as the market goes up and down. This approach can get you interested in edgy companies with the potential to be the market’s next lightning bolt, rather than more stable investments. You can also lose a lot of money by buying and selling during market swings, even if you intend to use them to your advantage.

Investors Prone to Fear

On the opposite side of the coin, fearful investors are equally vulnerable. You may find yourself sitting on your cash, unwilling to wade into the market. If you do invest, you could be prone to panic during market lows — and if you sell before you’ve owned an investment asset for less than a year, you may face higher taxes on any capital gains than you would if you’d sat on that purchase for a while.

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The amount of time your investments spend in the market matters, so it’s important to keep fear in check. Volatility can actually be an ally for an investor who uses dollar-cost averaging, as the more often the market dips, the more likely that your regular contributions will be picking up shares at cheaper prices. This can actually provide bigger long-term gains for the dollar-cost-averaging investor than if the market just continually moves slowly higher.

Would-Be Investors With Impostor Syndrome

Generally, the most vulnerable investors of all are the ones who never wade in. Investing is scary for many people, and they don’t typically learn about it at home or school. If this is you, there’s no shame in that, but dollar-cost averaging could be a comfortable way for you to begin investing.

Financially speaking, there’s no better friend than compound interest or the momentum that your investments gain over time. Although investing always carries some risk, there are ways to invest that help minimize that risk and provide the strongest opportunity for your wealth to grow gradually.

What Are the Pros and Cons?

Every investment strategy carries some risk. Before you decide how to spend your investment dollars, know the pros and cons.

Pros

• Removes emotions from your investment strategy
• Ensures all of your money doesn’t go in at the market peak
• Ensures that you’ll pick up extra shares when markets fall
• Provides you with a long-term average cost
• Builds good investment habits

Cons

• Can keep compounding losses if you invest in a security that never rises
• Potential for more fees if you make multiple transactions instead of a lump sum
• Can complicate taxes when you sell
• If you’re starting with a lump sum of money, you could risk missing gains if you invest it over time instead of all at once

Tips for Getting Started With Dollar-Cost Averaging

If you’re sold on this strategy but not sure how to begin, here’s some guidance.

1. Pick an Investment Vehicle

This could be a 401(k), an IRA, or a brokerage account that you direct money to regularly.

2. Choose a Frequency

In some investment vehicles, such as a 401(k), the frequency of your contributions is preset to every pay cycle. If you’re going to use dollar-cost averaging to direct funds to an IRA or a brokerage account, then you’re in charge of how frequent your contribution is. You may choose daily, weekly or monthly.

3. Set Your Contribution (and Forget It)

Figure out how much you can afford to dedicate to your chosen investment. Does 5% of your net income work? How about 10%? Make sure that the amount you choose is going to work, given the frequency of your contribution. This is the investment strategy that people often refer to as “set it and forget it.”

4. Consider Increasing Your Contributions Over Time

Once you’ve gotten in the habit of making regular contributions to your investment account, try to slowly raise the amount you allocate every year, or even every month if you’re ambitious. If you start by saving 5% of your salary in your 401(k) plan, for example, try bumping that up to 6%. The increase in your contribution will likely be negligible, and after a few months you’ll likely not even notice the additional money that you’re taking out of your paycheck. But these slight, regular bumps in your contribution rate can make a big difference over the long run when it comes to the size of your nest egg.

Managing a Dollar-Cost Averaging Strategy Over Time

The more experienced you become as an investor, the more tempted you’ll be to diversify your investing strategy. You might find that dollar-cost averaging works for a portion of your portfolio, but that giving yourself a little bit of leeway for more time-sensitive investments makes more sense. This largely depends on your level of knowledge and experience.

For example, once you are familiar with investing and have some confidence in doing your own research, you might consider maintaining your dollar-cost averaging strategy into an S&P 500 fund or other index fund in your 401(k), but starting a separate investment account in which you pick and choose individual stocks or funds. This way, you can have both a base, consistent investment account and one that may potentially generate additional gains if you’re a savvy investor.

Good To Know

Here are a few takeaways to keep in mind when considering this strategy:

• If you have a 401(k) at work, you may already be using dollar-cost averaging.
• Dollar-cost averaging provides you with a steady way to invest over time.
• When you invest the same amount consistently, you don’t have to worry about timing the market.

No matter how you decide to invest, the consistency that dollar-cost averaging brings to your financial life is an asset in and of itself. When you invest steadily over time, you buy at both ups and downs. This leaves you in the best position possible for growth without having to fixate on market fluctuations. That’s bound to be a reassurance for any investor.

John Csiszar contributed to the reporting for this article.

Last updated: June 24, 2024

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