Dollar-Cost Averaging - DCA

What is 'Dollar-Cost Averaging - DCA'

Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high. It is also referred to as a constant dollar plan.

BREAKING DOWN 'Dollar-Cost Averaging - DCA'

Eventually, the average cost per share of the security becomes smaller and smaller. Dollar-cost averaging lessens the risk of investing a large amount in a single investment at the wrong time. Since no one can predict the direction of the market, DCA is a strategy to eliminate any anxieties that arise from trying to time an investment decision, and it builds the discipline of investing regularly.

Dollar-Cost Averaging Example

With DCA, an investor invests the same amount into the same fund over a consistent time period. For example, assume an investor invests $1,000 on the first of each month into Mutual Fund XYZ. Assume that over a period of five months, the share price of Mutual Fund XYZ on the beginning of each month was as follows:

Month 1: $20

Month 2: $16

Month 3: $12

Month 4: $17

Month 5: $23

On the first of each month, by investing $1,000, the investor is able to buy a number of shares equal to $1,000 divided by the share price. In this example, the number of shares purchased each month is equal to:

Month 1 Shares = $1,000 / $20 = 50

Month 2 Shares = $1,000 / $16 = 62.5

Month 3 Shares = $1,000 / $12 = 83.33

Month 4 Shares = $1,000 / $17 = 58.82

Month 5 Shares = $1,000 / $23 = 43.48

Depending on the price, more shares were purchased during some months, and less shares were purchased during other months. Regardless, the total number of shares the investor owns is 298.14, and the average price paid for each of those shares is $16.77. Considering the current price of the shares is $23, this means an original investment of $5,000 has turned into $6,857.11.

If the investor had invested all $5,000 on one of these days instead of spreading the investment across five months, the total profitability of the position would be higher or lower than $6,857.11 depending on the month chosen for the investment. But as noted, no one can time the market, and DCA is a safe strategy to ensure an overall favorable average price per share.