What Is Dollar-Cost Averaging and How Does It Work?

What Is Dollar-Cost Averaging?

Dollar-cost averaging (DCA) is the practice of investing a fixed dollar amount on a regular schedule, no matter what the market is doing.

Instead of putting a lump sum into a stock or fund all at once, you divide your money into equal portions and invest them at set intervals, such as weekly, biweekly or monthly. Because the price of an investment changes over time, your fixed contribution buys more shares when prices fall and fewer shares when prices rise. Over the long run, this approach can lower your average cost per share.

You may already be using this strategy without realizing it. For example, each contribution to your 401(k) from a paycheck is a form of dollar-cost averaging. The point isn't to chase the perfect entry point; it's to stay invested consistently and let time do the heavy lifting.

How Does Dollar-Cost Averaging Work?

To see dollar-cost averaging in action, imagine you have $500 to invest in a fictional stock we'll call CRDT.

In one scenario, you invest the full $500 at once and buy 10 shares at $50 each. Your cost per share is locked in at $50. As long as you hold the stock, your cost basis (the price you initially paid) will remain $50.

In a second scenario, we'll use dollar-cost averaging. Here, you split the $500 into five weekly investments of $100 each. The price moves up and down, so each contribution buys a different number of shares:

After five weeks, you've spent the same $500 but bought roughly 10.39 shares at an average price of about $48.12 per share. By staying consistent, you bought more shares when the price dipped, lowering your average cost. If CRDT eventually climbs above $50, every share you bought below that price adds to your gains.

Pros and Cons of Dollar-Cost Averaging

Dollar-cost averaging is straightforward and easy to automate, but it isn't perfect. Here's what to weigh before committing to the strategy.

Should I Consider Dollar-Cost Averaging?

Dollar-cost averaging may be a good fit if you want to invest in the stock market but want to limit your exposure to short-term swings. It's also helpful if you don't have a lump sum on hand and prefer to invest steadily out of each paycheck.

If you contribute to an employer-sponsored 401(k), you're already dollar-cost averaging. The same approach works for an IRA or taxable brokerage account.

To reduce risk further, consider investing in an ETF or a mutual fund that holds many companies rather than putting everything into one stock. If you're not sure how to start investing, a financial professional can help you build a plan based on your goals and risk tolerance.

How to Implement a Dollar-Cost Averaging Strategy

Setting up a dollar-cost averaging plan takes only a handful of steps. Here's how you can get started:

1. Pick an investment account. This could be a 401(k), IRA or taxable brokerage account. Each one has different tax rules and contribution limits, so choose what fits your goals.
2. Choose your investments. Many investors use dollar-cost averaging with broad market mutual funds or ETFs because they offer instant diversification.
3. Set your contribution amount. Decide how much you can comfortably invest on a regular basis. Even small amounts can grow significantly over time.
4. Pick your schedule. Weekly, biweekly and monthly are all common intervals for DCA investing. Aligning contributions with your payday makes them easier to stick to.
5. Automate the transfers. Set up automatic deposits from your bank account or paycheck so you don't have to remember to invest each time.
6. Track your progress. Review your account at least once a year to see how your investments are performing and rebalance if your asset allocation has drifted.

Tip: If you get a raise, consider increasing your automatic contribution by the same percentage. You won't miss the money since it never hits your checking account, and the extra investment can pay off significantly over decades.

Frequently Asked Questions

The Bottom Line

Dollar-cost averaging is a simple, hands-off way to build wealth over time without trying to outsmart the market. It won't always produce the highest returns, but it can keep you invested consistently and help you avoid emotional decisions during turbulent stretches.

Investing is just one piece of a bigger financial picture, though. Before you put money in the market, make sure you have an emergency fund and a plan to pay off any high-interest debt. Good credit also gives you more flexibility when goals like buying a home come into view. You can check your credit report and FICO^® Score^Θ for free with Experian.