Dollar-Cost Averaging

Dollar-Cost Averaging

An investment strategy in which one makes investments in the same dollar amount at regular times. For example, one may buy $1,000 in Stock A every month, regardless of Stock A's current price. Because this means one buys fewer shares when the price is high and more when the price is low, dollar-cost averaging aims to reduce the average cost of the shares one buys. This increases the profit per share when one sells the stock. Dollar cost averaging is most common with shares of a mutual fund or a retirement plan. It is also called a constant dollar plan.

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dollar-cost averaging

Investment of a fixed amount of money at regular intervals, usually each month. This process results in the purchase of extra shares during market downturns and fewer shares during market upturns. Dollar-cost averaging is based on the belief that the market or a particular stock will rise in price over the long term and that it is not worthwhile (or even possible) to identify intermediate highs and lows. Also called averaging.

What types of investors should use dollar-cost averaging?

When asked what the market was going to do, J. P. Morgan reportedly said, "It will fluctuate." Morgan was right! This concept refers to putting a fixed amount of money into securities periodically. In so doing, one's average price per share is lower than the mean average price during the holding period. This is basic math: $100 buys 10 shares of a stock at $10, and 5 shares at $20 when the market is higher. The mean average price is $15. But the investor owns 15 shares and paid just $200 for an average price per share of just $13.33. TIP: A good approach for smaller investors just getting started, and also for IRAs. It works particularly well with diversified mutual funds.

Thomas J. McAllister, CFP, McAllister Financial Planning, Carmel, IN

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Dollar-Cost Averaging (DCA)

What Does Dollar-Cost Averaging (DCA) Mean?

The technique of buying a fixed dollar amount of a particular investment on a regular schedule regardless of the share price. By using DCA, an investor is continually buying shares, some when the stock price is down and some when the stock price is up, with the goal of averaging out the price of all shares purchased. Also referred to as a constant dollar plan.

Investopedia explains Dollar-Cost Averaging (DCA)

Eventually, the average cost per share of the security will become smaller and smaller. Dollar-cost averaging lessens the risk of investing a large amount in a single investment at the wrong time. For example, consider a $100 purchase of XYZ each month for three months. In January, XYZ is worth $33, and so the investor buys three shares. In February, XYZ is worth $25, and so the investor buys four additional shares. Finally, in March, XYZ is worth $20, and so the investor buys five shares. In total, the investor winds up purchasing 12 shares for an average price of approximately $25 each. In the United Kingdom, this is called pound-cost averaging.

Related Terms:
• Common Stock
• Compounding
• Dividend Reinvestment Plan—DRIP
• Mutual Fund
• Net Asset Value