Dollar-cost averaging (DCA) is a very effective strategy for investors who are new to investing and are unsure about when or how to get involved in the market. It is also effective for investors who may lack the discipline required to make regularly timed investments.
This investment strategy is designed to ensure that novice investors contribute a fixed amount of money automatically and are not left with second thoughts that could delay putting money to work in the market. If you’re nervous about the best time to put money into an investment, then DCA is an effective solution to this problem by spreading out contributions over time.
DCA is an advantageous strategy because it can prevent the regret that can come from buying a stock and then watching the price decline. DCA puts money in the market gradually and allows you to purchase more shares when they are cheap and fewer when they’re expensive.
This allows you to buy a stock or ETF at an average price per share over an extended period of time, and it diversifies the risk of placing a large sum of money in the market at one time.
All strategies come with risks, however, and DCA is no exception. The major risk of using DCA is that it keeps your money out of the market for a longer period of time than lump-sum investing. This can be a problem if a stock or ETF is rising in price. Over a specified investment horizon, for example one year, returns in this scenario will be lower for DCA than for lump-sum investing.
The reason for this is that a portion of the money that you could have earned a return with lump-sum investing from the beginning is instead left in cash for several months as you implement the DCA strategy.
For DCA to be executed properly, you need to keep in mind that regular fixed contributions are essential. If you make irregular contributions, or delay the investment process, then DCA will not achieve the results intended. If you don’t take advantage of buying more shares when prices are low and fewer shares when prices are high, then the benefits of DCA are largely lost.