Dollar-Cost Averaging: What It Is and How It Works

Dollar-cost averaging is an investment approach in which a person invests the same amount of money at regular intervals instead of investing the entire amount at one time.

What Is Dollar-Cost Averaging?

Under a dollar-cost averaging approach, a fixed amount is invested according to a regular schedule. Depending on the investment price at each interval, the same amount of money may purchase more or fewer units.

This approach is commonly discussed in the context of long-term investing and regular contributions. However, it does not guarantee profits or protect against investment losses.

How Dollar-Cost Averaging Works

When investment prices are lower, a fixed contribution can generally buy more units. When prices are higher, the same contribution generally buys fewer units.

The actual result depends on the prices at which purchases occur, the investment selected, fees, taxes and other factors.

Potential Benefits

• It can encourage regular investing habits.
• It may reduce the need to decide when to invest every contribution.
• It spreads purchases across different points in time.
• It can be easier to manage through a regular investment schedule.

Potential Limitations

Dollar-cost averaging does not remove investment risk. If an investment declines in value for an extended period, regular contributions can still lose value.

• Investment values can rise or fall.
• Regular investing does not guarantee positive returns.
• Fees and expenses can affect results.
• Taxes may affect net returns.
• A lump-sum investment and regular investing can produce different outcomes.

Dollar-Cost Averaging vs Lump-Sum Investing

With lump-sum investing, the available amount is invested at one time. With dollar-cost averaging, the amount is divided into multiple investments over a period.

Neither approach is automatically suitable for everyone. The outcome can depend on market movements, investment time horizon, risk tolerance, available capital and personal circumstances.

What Happens When Prices Change?

Price changes affect the number of units that can be purchased with each fixed contribution. A lower price generally allows the same contribution to purchase more units, while a higher price generally allows it to purchase fewer units.

However, buying more units at lower prices does not guarantee that the investment will later increase in value.

Factors to Consider

• Your investment goals.
• Your investment time horizon.
• Your ability to invest regularly.
• The risks associated with the investment.
• Fees and expenses.
• Taxes where applicable.
• Your overall asset allocation.

Is Dollar-Cost Averaging a Guarantee?

No. Dollar-cost averaging is an investment approach, not a guarantee of profits or protection against losses. Investment markets can fluctuate, and the value of an investment may fall.

Key Takeaways

• Dollar-cost averaging involves investing a fixed amount at regular intervals.
• The same contribution may buy more or fewer units depending on the price.
• The approach can help create a regular investing habit.
• It does not eliminate market risk or guarantee returns.
• Fees, taxes and investment performance can affect actual results.