Dollar-cost averaging (DCA) is an investment strategy wherein you invest the same amount at regular intervals regardless of security prices. Long-term, DCA can average out your purchase prices, minimize the impact of market volatility and reduce the temptation to time the market.
DCA involves regularly investing the same amount of money irrespective of the purchase price of a given security. It’s often a key component of passive investment strategies and can apply to all types of securities, including:
The idea behind DCA is that security prices will generally rise. In fact, that’s a primary reason to invest. Unfortunately, short-term market volatility makes it impossible to accurately predict when an investment will move in which direction.
DCA removes the temptation to try timing the market and instead focuses on making regular investments to build a portfolio over time. Though it can’t protect you from declining market prices, it can average out the purchase price you pay for any given investment.
A common example of DCA is your 401(k) or IRA plan. Every time you invest in your retirement account, your plan administrator invests the money regardless of security prices. Over time, you’ll build a large portfolio of securities that (hopefully) continue to appreciate in price.
Dollar-cost averaging can be a valuable strategy for several reasons.
One of the biggest perks of DCA is the impact on your long-term cost basis. Over time, making regular contributions can smooth out your returns by generating lower losses on declining investments and greater gains on well-performing ones.
Those who use DCA may notice that they’re less affected by market volatility or less tempted to try timing the market. While stomaching a market crash can be a tall order, it’s easier if you’re already in the habit of buying the lows, highs and everything in-between.
If you don’t have a lot of cash lying around, DCA can help encourage regular investments regardless of market performance. Because you purchase the same dollar amount of an asset regularly, you buy fewer shares when prices rise and more shares when prices drop. But over time, you’ll still increase your holdings and grow your wealth.
With a long-term strategy, dollar-cost averaging can:
But there is a catch: This method is most effective if you apply it toward funds or your broader portfolio, rather than individual securities.
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