Dollar-cost averaging (DCA) is a wealth-building strategy that involves investing a fixed amount of money at regular intervals over a long period. This type of systematic investment program is familiar to many investors, as they practice it with their 401(k) and 403(b) retirement plans. When it comes to implementing investment strategies based on dollar-cost averaging, there may be no better investment vehicle than the no-load mutual fund - the structure of these mutual funds almost seems to have been designed with dollar-cost averaging in mind. Here we look at why, helping you use dollar-cost averaging when investing in mutual funds.

Review of Dollar-Cost Averaging
Dollar-cost averaging is carried out simply by investing a fixed dollar amount into your mutual fund (or other investment instrument) at pre-determined intervals. The amount of money invested at each interval remains the same over time, but the number of shares purchased varies based on the market value of the shares at the time of a purchase. When the markets are up, you buy fewer shares per dollar invested due to the higher cost per share. When the markets are down, the situation is reversed and you purchase a greater of number of shares per dollar invested. It's a strategic way to invest because you buy more shares when the cost is low, so you get an average cost per share over time, meaning you don't have to invest the time and effort to monitor market movements and strategically time your investments. (For more on how dollar-cost averaging works, see DCA: It Gets You In At The Bottom.)

Why Dollar-Cost Averaging Works Well With Mutual Funds
The expense ratio that mutual fund investors pay to invest in a fund is a fixed percentage of your contribution. That percentage takes the same relative bite out of a $25 investment or regular installment amount as it would out of a $250 or $2,500 lump-sum investment. Compared to stock trades, for example, where a flat commission is charged on each transaction, the value of the fixed-percentage expense ratio is startlingly clear. Consider the following:

Example A

  • By making a $25 installment in a mutual fund that charges a 20 basis-point expense ratio, you pay $0.05, which amounts to a 0.2% fee.
  • By making a $250 lump-sum investment in the same fund, you pay $0.50, or a 0.2% fee.

Example B

  • By making a $25 investment in a typical stock through a broker who charges $10 commission per trade, you pay $10, which amounts to a 40% fee.
  • By making a $250 investment in a typical stock through a broker who charges $10 commission per trade, you pay $10.00, which amounts to a 4% fee.

The examples above show that you have to buy more stock in order for the percentage of the commissions to go down. In comparison, the structure of the mutual fund expense ratio makes the investment more accessible: the no-commission trading of the mutual fund coupled with low minimum investment requirements allows almost everyone to afford mutual funds.

Furthermore, many mutual funds waive their required minimums for investors who set up automatic contribution plans (plans that put dollar-cost averaging into action). All this enables low-wage earners and folks with tight budgets to invest $10 or $25 or another nominal amount on a regular basis without worrying about the impact of trading costs. While small contributions may not seem impressive at first glance, they enable investors to get into the habit of saving, and can really add up over the course of a lifetime thanks to the power of compounding.

Of course, dollar-cost averaging with mutual funds isn't a strategy that is limited to use by the less than affluent. If you have a large sum of money and invest it all at once, you face the risk that declining financial markets will take a huge chunk out of your portfolio. Dollar-cost averaging offers the perfect solution to your dilemma. To facilitate a long-term strategy for investing large sums of money, many mutual funds offer investors the ability to make a lump-sum investment in a money market fund, from which predetermined amounts are automatically invested into a designated higher-risk mutual fund at pre-arranged intervals. It's a convenient, cost-efficient solution that mitigates concerns about investing a large sum of money at the wrong time.

A Long-Term Strategy
Regardless of the amount of money that you have to invest, dollar-cost averaging is a long-term strategy. While the financial markets are in a constant state of flux, they tend to move in the same general direction over fairly long periods of time. Bear markets and bull markets can last for months, if not years. Because of these trends, dollar-cost averaging is generally not a particularly valuable short-term strategy.

Consider, for example, an investor making 10 purchases of a mutual fund's shares over the course of a month. While it is unlikely that the purchase price of the shares will be identical for each transaction, it is also unlikely that they will differ significantly over such a short time frame.

On the other hand, over the course of a market cycle lasting five or 10 years and including a bull market and a bear market, the price of a given security is likely to change significantly. Dollar-cost averaging will help to ensure that your average cost per share represents both the premiums of a bull market and the discounts of a bear market, as opposed to just the premiums usually paid by investors in a bull market.

Conclusion: Keep Costs in Mind
While low, percentage-based expense ratios make mutual funds the perfect vehicle for dollar-cost averaging, it pays to exercise caution when it comes to your investments. Some mutual funds charge low-balance fees, sales loads, purchase fees and/or exchanges fees. Be sure to read the disclosure materials prior to investing and make sure you are aware of all expenses associated with your investments.

Related Articles
  1. Mutual Funds & ETFs

    5 Reasons to Choose Mutual Funds over ETFs

    Discover five reasons to choose mutual funds over ETFs, such as the wide variety of funds available, the higher service quality and the lack of commission fees.
  2. Mutual Funds & ETFs

    Invesco’s Top Funds for Retirement

    Here's a list of Invesco investments—retirement funds—that may work for you if you have the time to let them mature over the long term.
  3. Mutual Funds & ETFs

    Top 4 Royce Funds for Retirement Diversification in 2016

    Discover four of The Royce Funds mutual funds suitable for diversifying retirement portfolios that focus on investing in small-cap companies.
  4. Savings

    What Your Credit Score Means for Your Love Life

    Wondering if your significant other wants to commit and is reliable? The Fed might have the answer.
  5. Mutual Funds & ETFs

    Top 3 VALIC Funds for Retirement Diversification in 2016

    Learn about the VALIC fund family, its performance relative to its peers and the top three VALIC funds to consider for retirement diversification in 2016.
  6. Your Clients

    Tips for Making Your Nest Egg Last Longer

    If you’re trying to figure out how to make your hard-earned nest egg last, there’s one piece of advice that stands above the rest.
  7. Mutual Funds & ETFs

    The 4 Best T. Rowe Price Funds for Growth Investors in 2016 (TROW)

    Discover the four best mutual funds administered and managed by T. Rowe Price that specialize in investing in stocks of growth companies.
  8. Mutual Funds & ETFs

    The 3 Best T. Rowe Price Funds for Value Investors in 2016

    Read analyses of the top three T. Rowe Price value funds open to new investors, and learn about their investment objectives and historical performances.
  9. Mutual Funds & ETFs

    Top 3 Lazard Funds for Retirement Diversification in 2016

    Learn about Lazard Asset Management, its long history of strong performance and the top three Lazard funds to consider for retirement diversification.
  10. Investing

    3 Healthy Financial Habits for 2016

    ”Winning” investors don't just set it and forget it. They consistently take steps to adapt their investment plan in the face of changing markets.
RELATED FAQS
  1. What are the benefits and costs (or risks) of a systematic investment plan (SIP)?

    A systematic investment plan (SIP) is used to invest a specified dollar amount on a predetermined schedule. For example, ... Read Full Answer >>
  2. What are the differences between a systematic investment plan (SIP) and a recurring ...

    Budgeting for retirement and other investment goals can be difficult for many individuals. The importance of saving, especially ... Read Full Answer >>
  3. How liquid are BlackRock mutual funds? (BLK)

    BlackRock, Inc. (NYSE: BLK) mutual funds are very liquid, as are all mutual funds. An investor receives payment for a redemption ... Read Full Answer >>
  4. Am I losing the right to collect spousal Social Security benefits before I collect ...

    The short answer is yes, if you haven't reached age 62 by December 31, 2015. The Bipartisan Budget Act of 2015 disrupted ... Read Full Answer >>
  5. What's the difference between a stop and a limit order?

    Different types of orders allow you to be more specific about how you'd like your broker to fulfill your trades. When you ... Read Full Answer >>
  6. Are target-date retirement funds good investments?

    The main benefit of target-date retirement funds is convenience. If you really don't want to bother with your retirement ... Read Full Answer >>
Trading Center