Financial Concepts: Dollar Cost Averaging
  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. Dollar-Cost Averaging - DCA

    The technique of buying a fixed dollar amount of a particular ...
  2. Value Averaging

    An investing strategy that works like dollar cost averaging (DCA) ...
  3. Average Up

    The process of buying additional shares at higher prices. This ...
  4. Investing

    The act of committing money or capital to an endeavor with the ...
  5. Drip Feed

    1. The process of investing on an ongoing basis in a small but ...
  6. Average Down

    The process of buying additional shares in a company at lower ...
RELATED FAQS
  1. Which is better: dollar cost averaging or value averaging?

    Compare the two investment strategies of dollar cost averaging and value averaging, and learn which one usually generates ... Read Answer >>
  2. Over what period should I use dollar cost averaging?

    Learn why dollar cost averaging should be implemented over a period of time that is 12 months or less in order to avoid missing ... Read Answer >>
  3. For what investments is dollar cost averaging most effective?

    Understand why dollar cost averaging is best for volatile asset classes and less than ideal for more stable types of asset ... Read Answer >>
  4. If I own stock that drops in price is this a sign that I should buy more?

    This is a good question, and the answer has two parts. First, let's address the concept underlying the strategy to which ... Read Answer >>
  5. How can I protect my portfolio from market corrections?

    Learn about some of the types of investment strategies designed to protect an investment portfolio from losing value during ... Read Answer >>
  6. I want to invest in equities, but I don't have much money. Is there a minimum number ...

    The short answer is "no" - you can buy a single share of any publicly traded company if you want to. Thus, if you have a ... Read Answer >>
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