What is Dollar Cost Averaging?
Dollar Cost Averaging (DCA) is an investment strategy where rather than investing all the available capital at once, incremental investments are gradually made over time.
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How Does Dollar Cost Averaging Work?
The dollar cost averaging (DCA) strategy is when investors invest their funds in set increments, as opposed to putting all the capital on hand to use immediately.
The rationale behind the dollar cost averaging (DCA) strategy is to be well-positioned for an unexpected downturn in the market without placing too much capital at risk of loss.
If we assume post-purchase, there is short-term market volatility and the price of the purchased asset declines, DCA is designed to provide the investor with the optionality to invest more at the reduced price.
By purchasing more shares at a lower price than the original price, the average price paid per share also declines, which makes it easier to profit since the hurdle (i.e. original share price) has been lowered.
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What is DCA Investing Strategy?
One common mistake made by many investors is attempting to “time the market,” but dollar cost averaging (DCA) can remove the need to time the “top” or “bottom” in the market – which are typically futile attempts, even for investment professionals.
Therefore, DCA saves you the effort of trying to time the market with the optionality to purchase more shares to bring down the average price paid per share – i.e. the “cost basis.”
For investors, especially for value investors and retail investors, the simplicity of DCA can be a useful tool for investing patiently and protects against the impulse to risk the entire amount for higher returns.
The concept of dollar cost averaging (DCA) is to invest your capital in regular portions over time.
- DCA Investing: Since the investment was not made as a single lump-sum payment, DCA can lower the cost basis of the investments. Even if the share price continues to decline, the investor assumes the market will eventually recover.
- Lump Sum Payment: Conversely, if you would have invested the entirety of the amount due in one single payment – i.e. in a poorly timed investment – the only method to bring the cost-basis down is to contribute more capital.
Dollar Cost Averaging Formula (DCA)
The formula for calculating the average share price paid is as follows:
