Financial Concepts: Dollar Cost Averaging
AAA
  1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion

Financial Concepts: Dollar Cost Averaging


If you ask any professional investor what the hardest investment task is, he or she will likely tell you that it is picking bottoms and tops in the market. Trying to time the market is a very tricky strategy. Buying at the absolute low and selling at the peak is nearly impossible in practice. This is why so many professionals preach about dollar cost averaging (DCA).

Although the term might imply a complex concept, DCA is actually a fairly simple and extremely useful technique. Dollar cost averaging is the process of buying, regardless of the share price, a fixed dollar amount of a particular investment on a regular schedule. More shares are purchased when prices are low, and fewer shares are purchased when prices are high. The cost per share over time eventually averages out. This reduces the risk of investing a large amount in a single investment at the wrong time.

Let's analyze this with an example. Suppose you recently got a bonus for your previously unrecognized excellence (just imagine!), and now you have $10,000 to invest. Instead of investing the lump sum into a mutual fund or stock, with DCA, you'd spread the investment out over several months. Investing $2,000 a month for the next five months, "averages" the price over five months. So one month you might buy high, and the next month you might buy more shares because the price is lower, and so on.

This plan is also applicable to the investor who doesn't have that big lump sum at the start, but can invest small amounts regularly. This way you can contribute as little as $25-50 a month to an investment like an index fund. Keep in mind that dollar cost averaging doesn't prevent a loss in a steadily declining market, but it is quite effective in taking advantage of growth over the long term.

Financial Concepts: Asset Allocation

  1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion
RELATED TERMS
  1. Strike Width

    The difference between the strike price of an option and the ...
  2. Systematic Manager

    A manager who adjusts a portfolio’s long and short-term positions ...
  3. Inverse Transaction

    A transaction that can cancel out a forward contract that has ...
  4. Unconstrained Investing

    An investment style that does not require a fund or portfolio ...
  5. Reference Equity

    The underlying equity that an investor is seeking price movement ...
  6. Precedent Transaction Analysis

    A valuation method in which the prices paid for similar companies ...
  1. What Book Value Of Equity Per Share (BVPS) ratio indicates a buy signal?

    Find out more about book value of equity per share, what BVPS measures and how to determine what level of BVPS indicates ...
  2. What is the effective interest method of amortization?

    Find out more about the effective interest rate method and how the effective interest method is used to amortize a discounted ...
  3. Is there a way to include intangible assets in book-to-market ratio calculations?

    Find out more about the book-to-market ratio and how to calculate a public company's book-to-market ratio including its intangible ...
  4. What risks should I consider taking a short put position?

    Learn what risks to consider before taking a short put position. Shorting puts is a great strategy to earn income in certain ...

You May Also Like

Related Tutorials
  1. Fundamental Analysis

    Ethical Investing Tutorial

  2. Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  3. Economics

    American Depositary Receipt Basics

  4. Economics

    Macroeconomics

  5. Investing Basics

    Capital Budgeting

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!