Loading the player...

What is 'Dollar-Cost Averaging - DCA'

Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. The investor purchases more shares when prices are low and fewer shares when prices are high. The premise is that DCA lowers the average share cost over time, increasing the opportunity to profit.

BREAKING DOWN 'Dollar-Cost Averaging - DCA'

Fundamental to the strategy is a commitment to investing a fixed dollar amount each month. Depending on an investor's investment objectives and risk profile, the monthly contributions can be invested in a mixed portfolio of mutual funds, exchange-traded funds (ETFs) or even individual stocks. Each month, the fixed amount buys shares at the then-current prices. As share prices decline, the fixed amount buys a higher number of shares; when prices increase, the fixed amount buys fewer shares. The real value of dollar-cost averaging is that investors don’t need to worry about investing at the top of the market or trying to determine when to get in or out of the market.

Dollar-Cost Averaging Example

For example, assume an investor invests $1,000 on the first of each month into Mutual Fund XYZ. Assume that over a period of five months, the share price of Mutual Fund XYZ on the beginning of each month was as follows:

• Month 1: $20

• Month 2: $16

• Month 3: $12

• Month 4: $17

• Month 5: $23

On the first of each month, by investing $1,000, the investor can buy a number of shares equal to $1,000 divided by the share price. In this example, the number of shares purchased each month is equal to:

• Month 1 shares = $1,000 / $20 = 50

• Month 2 shares = $1,000 / $16 = 62.5

• Month 3 shares = $1,000 / $12 = 83.33

• Month 4 shares = $1,000 / $17 = 58.82

• Month 5 shares = $1,000 / $23 = 43.48

Regardless of how many shares the $1,000 monthly investment purchased, the total number of shares the investor owns is 298.14, and the average price paid for each of those shares is $16.77. Considering the current price of the shares is $23, this means an original investment of $5,000 has turned into $6,857.11.

If the investor had invested all $5,000 on one of these days instead of spreading the investment across five months, the total profitability of the position would be higher or lower than $6,857.11 depending on the month chosen for the investment. However, no one can time the market. DCA is a safe strategy to ensure an overall favorable average price per share.

RELATED TERMS
  1. Average Up

    The process of buying additional shares at higher prices. This ...
  2. Systematic Investment Plan - SIP

    This is a plan where investors make regular, equal payments into ...
  3. Value Averaging

    An investing strategy that works like dollar cost averaging (DCA) ...
  4. Share Turnover

    A measure of stock liquidity calculated by dividing the total ...
  5. Purchase Price

    The price that an investor pays for a security. This price is ...
  6. Fully Paid Shares

    Shares issued in which no more money is required to be paid to ...
Related Articles
  1. Investing

    Dollar-Cost Averaging Pays

    Get the most out of your mutual fund by using this simple but powerful strategy.
  2. Trading

    Take Advantage Of Dollar-Cost Averaging

    We explain how dollar-cost averaging offers protection and opportunity in a sinking market.
  3. Investing

    Investing $100 a Month in Stocks for 20 Years

    Learn how a monthly investment of just $100 can help build a future nest egg using properly diversified stocks or stock mutual funds.
  4. Trading

    Choosing Between Dollar-Cost And Value Averaging

    These are two investing practices that seek to counter our natural inclination toward market timing by canceling out some of the risk.
  5. Investing

    The Basics Of Outstanding Shares And The Float

    We go over different types of shares and what investors need to know about them.
  6. Investing

    Don't Let Stock Prices Fool You

    Find out why a stock with a six-figure share price can still be a good value.
  7. Trading

    Pros & Cons Of Dollar Cost Averaging

    The dollar-cost averaging approach helps investors avoid market timing but they give up some potential for higher returns.
  8. Investing

    Dollar-Cost Averaging With ETFs

    If you are investing small amounts regularly into an exchange-traded fund, be sure to do it right.
  9. Investing

    What are Issued Shares?

    Issued shares are the amount of authorized stocks a company’s shareholders buy and own. The annual report shows the number of outstanding shares.
  10. Investing

    Are Mutual Funds Doomed?

    Decreases in mutual fund classes and the growing use of ETFs means the future of mutual funds will be anything but smooth.
RELATED FAQS
  1. What's the smallest number of shares I can buy?

    Unlike mutual funds, which can be purchased in fractional units, shares of stock cannot be divided. So, the smallest number ... Read Answer >>
  2. What are the benefits and costs (or risks) of a systematic investment plan (SIP)?

    Discover the advantages and disadvantages of using a systematic investment plan; you may lower your average cost, or you ... Read Answer >>
  3. What are the main differences between a systematic investment plan (SIP) and mutual ...

    Reduce your average cost per share on mutual fund investments using the dollar-cost averaging strategy by way of a systematic ... Read Answer >>
  4. Why would I need to know how many outstanding shares the shareholders have?

    Find out why shareholders should know how many outstanding shares have been issued by a corporation, and learn what happens ... Read Answer >>
Hot Definitions
  1. IRS Publication 970

    A document published by the Internal Revenue Service (IRS) that provides information on tax benefits available to students ...
  2. Federal Direct Loan Program

    A program that provides low-interest loans to postsecondary students and their parents. The William D. Ford Federal Direct ...
  3. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  4. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  5. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  6. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
Trading Center