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Dollar cost averaging
The simple strategy that can up your stock market game.
Key takeaways
- Dollar cost averaging is an investment strategy that involves making regular investments over a longer period of time.
- 1 in 3 Australian investors uses dollar cost averaging, according to Finder data.1
- You can use a calculator to see how much your investment could be worth over time if you used dollar cost averaging.
What is dollar cost averaging?
Dollar cost averaging (DCA) is a popular strategy that involves investing a fixed amount in an index fund or stock portfolio at regular intervals, regardless of the share price or market movements at any given time.
Essentially, it's a long-term investment strategy that helps reduce your exposure to volatility and draw downs while also benefitting from any gains in the market.
There's an old adage in investing that "time in the market beats timing the market," meaning it's better to have money invested in the stock market than trying to pick the best time to invest.
Dollar cost averaging is really just the embodiment of this approach.
One of the major advantages of dollar cost averaging is that it removes guesswork.
Even professional investors famously underperform the stock market over time, so the chances of regular investors correctly picking the best time to buy and sell are ultimately pretty slim.
It's investing on autopilot.
How does dollar cost averaging work?
Say you have $5,000 to invest.
Instead of investing it as a single lump sum, you split it into 5 separate $1,000 investments, which you make once a month for 5 months.
When the prices of your chosen stocks or funds go up, your $1,000 investment will buy fewer shares.
But when prices go down, it nets you more shares and reduces your average cost per share over time.
This way, your investment isn't as highly impacted by volatility as it would be if you purchased all your shares in one lump sum.
The key is that you continue to make regular investments over time, regardless of what the price is at any one point.
An example of dollar cost averaging
Let's use a basic dollar cost averaging strategy for investing in a fictional stock, ABC Inc.
On the first day of every month, you buy $1,000 worth of ABC shares (ignoring fees), regardless of what the share price is that day.
Here's a breakdown of those investments and their value:
| Month | ABC stock price | Shares purchased | Shares owned | Value of investment |
|---|---|---|---|---|
| January | $20 | 50 | 50 | $1,000 |
| February | $18 | 55.55 | 105.55 | $1,899.90 |
| March | $23 | 43.48 | 149.03 | $3,427.69 |
| April | $19 | 52.63 | 201.66 | $3,831.54 |
| May | $22 | 45.45 | 247.11 | $5,436.38 |
By May, the total investment of $5,000 ($1,000 X 5 months) is now worth $5,436.38.
But had you decided to invest that total in a single lump sum during any one of those months, the value of your investment could be higher or lower.
Say instead you got lucky and invested all $5,000 in February when ABC shares were $18.
You'd have been able to buy 277.78 shares, which would have been worth $6,111 by May.
That's a better return than the dollar cost averaging approach.
But say you waited until March to invest your $5,000 in one lump sum when the price was $23. You'd only have 217.4 shares, which would have been worth $4,782.60 by May.
So not only have you actually lost money on your investment, you'd also have missed the chance to buy more shares a month later at $19.
By using dollar cost averaging, you reduced the impact of volatility in the share price, while also being able to buy more when the stock dropped.
Of course, it's possible for investments to keep falling over time and if the price never recovers, no amount of dollar cost averaging would help turn that around.
Dollar cost averaging calculator
Use the calculator below to get a sense of the kind of returns you could expect over time by using a dollar cost averaging strategy.
What are the benefits of dollar cost averaging?
One of the key advantages of dollar cost averaging is that it steers you away from the risks of market timing and active trading.
Because you’re investing a fixed amount at different intervals regardless of the share price, you avoid emotional investing or buying more shares as prices rise and panic selling when they drop.
Dollar cost averaging gives you a steady, long-term investing strategy.
If you've bought quality assets and you expect that markets will go up over the long-term, then dollar cost averaging can help smooth out any bumps in the road on your investing journey.
We can all be unlucky and invest just before a share or the entire market falls, or hold fire and then see the stock we wanted to buy shoot up 20% in a month.
By using dollar cost averaging, you're more insulated from a badly-timed investment (or lack of investment) ruining your portfolio.
A study by Bloomberg found if you missed the best 40 days on the Australian stock market between 1995 and 2022 your returns would be just 3.3% compared to the ASX 200's yearly average of 9.5%.2
If you had been dollar cost averaging over that time, you'd have benefitted from all of the 40 best days.
Again, it gets back to the "time in the market over timing the market" philosophy we mentioned earlier.
You are likely already benefitting from this strategy even if you're not aware of it. This is because our superannuation system is designed around this approach.
Your employer takes 11.5% of your salary out of your check every payday and invests it in shares and various other assets with the aim of funding your retirement by the time you're 60 or older.
Our expert says: Dollar cost averaging is autopilot investing
"Using a dollar cost averaging strategy can take the stress and uncertainty out of investing. However, it's often more suited to investors targeting ETFs or blue-chip stocks as opposed to penny stocks."
Downside of dollar cost averaging
Like almost all regular investment strategies, dollar cost averaging assumes the price of your investments will rise over time.
But prices are constantly moving, and nobody can predict where they’re heading, especially on more volatile or unestablished stocks.
Utilising a dollar cost averaging strategy on shares you know little about can be especially risky. You may end up buying more shares at a time when selling was the better choice.
Ultimately, a bad investment is a bad investment, and not even dollar cost averaging can turn it into a good one.
This is why dollar cost averaging is also generally better suited towards investing in things like index funds or ETFs.
As ETFs track the performance of a broad range of stocks, you're better protected from the volatility you might see in a single stock.
Another potential disadvantage of dollar cost averaging is higher transaction costs. This is because you'll be trading more often when compared with adding a lump sum.
However, it's relatively easy to avoid these additional trading costs.
Some share trading platforms charge a percentage fee, which means your total fees will be the same whether you use dollar cost averaging or invest via a single lump sum.
Other brokers like CMC Invest actually offer free brokerage on the first trade up to $1,000 each day, which means it would actually be more cost-effective to use a dollar cost averaging strategy than a lump sum.
It also takes away any potential benefits of active trading.
For most retail investors this is arguably a positive, given how hard it actually is to time the market.
However, it's entirely possible dollar cost averaging could give you a lower overall return compared with someone who keeps their powder dry during a market fall and buys near the bottom.
Finder survey: What investment strategies do Australians use?
| Response | |
|---|---|
| ETF investing | 64.29% |
| Long-term investing | 55.71% |
| Dollar-cost averaging | 32.86% |
| Buying shares directly | 24.29% |
| Round-up investing | 22.86% |
| Investing for retirement | 12.86% |
| Short-term gains | 11.43% |
| I don't have any investing strategies | 1.43% |
| Not sure | 1.43% |
Source: Finder survey by Pure Profile of 1145 Australians, December 2023
When is dollar cost averaging most appropriate to use?
While pretty much any retail investor can in some way benefit from regularly adding money to a share portfolio, this strategy might be more suitable for index funds or mutual funds.
This is because you'll constantly be adding to a basket of shares instead of one individual company for that period.
At the same time, this strategy also helps investors ensure they add to all their stocks over a given time frame.
While for most, putting money into say 20 or more individual positions might be too much every pay cheque, a dollar cost average approach can still be beneficial. You'll just need to average your investment over a number of pay cycles.
But in either case, it’s crucial to examine the fundamentals of any investment before choosing an approach.
Moreover, dollar cost averaging is best used as a long-term strategy. While markets are in constant flux, prices generally don’t change much in the short term.
You have to keep your dollar cost averaging strategy in play through a long period to benefit from the low prices of a bear market and the high prices of a bull market. This means staying invested for years, if not decades.
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