What Is Dollar-Cost Averaging (DCA)?

What is dollar cost averaging, how does it work and how can investors use it to maximise their investment returns over time?

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What is dollar-cost averaging (DCA)?

If you’re struggling to comprehend all the complexities of investing and want a simple investment system, look no further. Dollar-cost averaging (DCA) is an uncomplicated, easy method where you invest on a consistent basis and, despite market fluctuations, your returns end up being profitable over time.

In this article, you’ll learn how to invest like a pro and conceptually grow your wealth over time without analysing the markets every day with anxiety. You’ll also learn the potential benefits behind dollar-cost averaging, examples of how it is used, and how you can begin applying this powerful method of investing.

Understanding dollar-cost averaging: How it works

Dollar-cost averaging is a popular strategy among investors who want simplicity when it comes to investing in the long term. It’s suited toward investors with a lower risk tolerance, and mainly geared towards the ‘set and forget’ investing mindset.

So let’s have a look at dollar-cost averaging being applied by two investors.

Let’s say investor 1 has $5,000 and invests everything in one go.

Month 1

  • Investment: $5,000 
  • Share price: $10 
  • Units purchased: 500

This investor now has 500 units invested. 

Now, let’s have a look at an investor who utilises dollar-cost averaging and invests $1,000 consistently over 5 months, rather than as a lump sum up front.

Month 1

  • Investment: $1000 
  • Share price: $10 
  • Units purchased: 100

Month 2

  • Investment: $1000 
  • Share price: $2
  • Units purchased: 500

Month 3

  • Investment: $1000 
  • Share price: $7
  • Units purchased: 143

Month 4

  • Investment: $1000 
  • Share price: $1
  • Units purchased: 1,000

Month 5

  • Investment: $1000 
  • Share price: $9
  • Units purchased: 112

As you can see, investor 1 invests $5,000 in month 1, and that investor has only 500 units.

However, investor 2 has invested $1,000 each month over a 5-month period and in the end, has more than 1,855 units. Amazing!

This is the power of dollar-cost averaging.

Of course, the market fluctuates due to a wide variety of factors such as global pandemics, government changes, commodity supply and demand, news updates, and more. With all these changes, the market goes up and down, but over time, it evens itself out.

It’s easy to set up the dollar-cost averaging method by investing into your superannuation fund. This is usually done automatically when you work for a company. However, be sure to double-check your existing setup and see whether your super fund is allocated to the correct asset classes that have historical return on investment.

Your super fund is most likely to be investing in a well-diversified portfolio. Your regular contribution is simply buying shares despite what trend the market is in. As a result, the more contributions you make on a regular basis, the more you grow your wealth. 

Benefits of dollar-cost averaging 

There are many benefits of dollar-cost averaging, so let’s take a closer look at each one below.

There’s no need to time the markets

Waiting for the market to reach a certain price point is like waiting for Donald Trump to give up his taxes – it ain’t gonna happen. However, when you invest every month, despite what the share price is, you’re always going to purchase lower priced shares and reap the benefits in the future.

Focus

Analysing the markets, studying trends, and reading financial reports can be a full time job. Most casual investors don’t necessarily have time for that. If you have a job or business, you likely won’t have that extra time to read up on your investments before making a purchase.

With dollar-cost averaging, you simply invest at regular intervals, and regardless of the share’s price. Therefore, you can focus more on your job or business which is producing income to invest back into your portfolio.

Easy to apply

It’s very easy to apply dollar-cost averaging. All you have to do is simply click the ‘buy’ button and you’re off to the races. There’s no financial complexity behind it – just remind yourself to make the investment and you’re done!

The bottom line

Dollar-cost averaging is very attractive for beginner investors, as the barrier to entry is low. Additionally, you don’t need any specialised knowledge, complex understandings of financial instruments, or hours of time for market analysis to get started.

All you need is the commitment and discipline to stick to this method for a long period of time and watch your bank account grow.

Although dollar-cost averaging doesn’t guarantee a profit in the short term, overtime, it will help even out the market fluctuations and enable you to grow your portfolio and create greater wealth.

Last updated 22nd July, 2021. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.