What is Dollar-Cost Averaging (DCA)?

Updated Oct 05 2021

A Beginners Guide to Dollar-Cost Averaging (DCA) with Examples

Dollar-Cost Averaging is an investment strategy that consists of executing small regular purchases of an asset over prolonged periods of time regardless of its current market prices.

In simple words, instead of dropping a huge bag of cash in the markets, a Dollar-Cost averaging investor sets smaller recurring purchases (weekly, monthly, etc) and constantly buys assets without caring if they are currently “cheap” or “expensive” with the objective of reducing the impact of price changes while accumulating as much assets as possible.

Let’s think about it this way: Every time you feel the need to drink a cold beer or to eat that nice restaurant meal, that could have been an extra stock or crypto purchase into your portfolio! Now, don’t be fooled by how simple this sounds, there are a few tips and tricks that can have a great impact on your investment strategy, so let’s dive in!

Table of contents:

How does Dollar-Cost Averaging work?

Dollar-Cost averaging works by allowing an investor to execute smaller regular purchases instead of a big one because prices have always shown a tendency to go up in the long term regardless of market crashes or any other temporary adverse conditions. 

To illustrate how powerful is this strategy, let’s take a look at the following example:

Dollar Cost Averaging Explained

A Dollar-Cost Averaging investor decides to invest $1800 over the course of 6 months by making monthly purchases of $300 of any particular asset. The table below serves as an example of how this scenario plays out:

Month Asset’s Price Total Quantity Purchased
Month 1 $100 3
Month 2 $120 3.5
Month 3 $80 3.75
Month 4 $90 3.33
Month 5 $110 2.72
Month 6 $115 2.6
Totals 17.9

Over the course of 6 Months, our investor accumulated 17.9 units of a particular asset by investing $300 monthly, he never cared about the current market prices.

Thanks to Dollar-Cost Averaging, our investor’s assets total worth are $2,058.5 at Month 6. So his initial investment of $1,800 yielded him a nice profit of 14.36% over his initial investment (a profit of $258,48).

Notice how the highest price of our asset was $120 and even though in this example, prices never rose above that all time high, our investor still made money and there lies the power of Dollar-Cost Averaging.

Now, what would have happened if our investor tried to time his entry to the markets?

Bear in mind that this is an extremely simplified example to give you a good understanding of the concept of Dollar-Cost Averaging. In normal circumstances, people engage in this strategy over several years.

What we can learn from this is that Dollar-Cost Averaging definitely simplifies the process of investing and reduces the risk for inexperienced investors that want to profit from the financial markets by diluting the risk over long periods of time.

So, can I Dollar-Cost Average anything and always make money?

Hell no! You can’t and here’s why:

Dollar-Cost Averaging is a well applied strategy on low risk diversified assets, for example: an S&P 500 fund, ETFs, etc.

The reason for this is that such financial instruments are not dependent on a single asset (stock in this case) for them to suffer a major crash and also that the general overall tendency of the stock market as a whole is to keep rising.

Just because tomorrow one of the biggest companies on the S&P 500 collapses it doesn’t mean that the whole S&P500 becomes worthless as we still rely on the assumption that all the other companies will continue to do business and grow.

Having said this, it doesn’t mean that you can't try to Dollar-Cost Average risky assets or individual stocks. The only issue here is that once you step into the realms of individually selecting stocks, cryptos or any asset you’re thinking about, then you’re dramatically increasing your risks if you don’t know what you’re doing and how to choose assets very well.

A good example would be:

Did the S&P 500 share the same fate?

Not at all!

Since the year 2010 the S&P 500 has accomplished an outstanding 4x in value!

So remember, we’re not saying that investing through Dollar-Cost Averaging in individual assets is impossible, all we’re saying is that it will require then far more analysis to not dump your money into something that could be worthless whereas in comparison, investing in an S&P 500 fund is a much safer and diversified investment.

The level of risk is entirely up to you and your financial analysis capabilities. If you’re keen on learning about picking stocks, we recommend you to read our guide on how to buy stocks as we chose a completely random example and went through the logical process of reviewing a company to see if we like it or not.

Examples of Dollar-Cost Averaging

What you’re about to see are particular examples of how investing using Dollar-Cost Averaging would have turned out in several different assets. 

Example of Dollar-Cost Averaging Bitcoin

For our Bitcoin’s Dollar-Cost Averaging simulation we’ll use the following variables:

Dollar-Cost Averaging Bitcoin Example

From the example above we can conclude the following:

Again, we can’t stress this enough: Dollar-Cost Averaging a single asset such as an individual stock or cryptocurrency, means having a high risk exposure due to lack of diversification, which requires great analysis from the investors side to determine if it’s worth investing in an individual asset or not.

What we can also learn from this example is a confirmation to a very true saying:

A normal person would have to work very hard to produce $416,000 in clean profits in his bank account, whereas an investor with extra $100,000 laying around can end up with those juicy profits by being patient and carefully selecting an asset to invest in over the course of 4 years.

The financial markets are a unique vehicle for creating wealth for those that do their homework!

Example of Dollar-Cost Averaging Ethereum

For our Ethereum Dollar-Cost Averaging simulation we’ll use the following variables:

Notice how this time we chose a very low and reachable amount ($100 monthly) to prove the point of how every single cent we spend on luxury purchases, drinks or restaurants could have become wealth if placed in the right vehicle.

Dollar-Cost Averaging Ethereum Example

From the example above we can conclude the following:

How do you feel after reading this?

Basically, all you need to do is take a job at Mcdonalds and throw $100 out of your salary in Ethereum over the course of 4 years to generate $51,000 in clean profits.

Example of Dollar-Cost Averaging Stocks 

For our stocks Dollar-Cost Averaging simulation we’ll use the following variables:

Dollar-Cost Averaging Stocks

From the example above we can conclude the following:

Example of Dollar-Cost Averaging ETFs

ETFs are nothing more than a customisable financial instrument that be designed to track the price of a particular industry (technology, health, etc) by grouping a lot of related assets, cryptocurrencies, commodities or even to mirror the price of an index.

When it comes to diversified investing, there are no better choices for investors than ETFs or funds as they provide exposure to multiple assets and industries which also reduces the risk of a single stock or asset falling.

For our ETFs Dollar-Cost Averaging simulation we’ll use the following variables:

Dollar-Cost Averaging ETFs Example

From the example above we can conclude the following:

Now, let’s hold and think for a second about what happened here:

But what would have happened if you chose to Dollar-Cost Average General Electric shares?

General Electric Shares Example

Notice where we’re going with all of this?

Dollar-Cost Averaging is a powerful investment strategy but there are a few points any investor must always remember:

Example of Dollar-Cost Averaging Funds

Now that you’ve got everything figured out with the previous examples in several asset classes, instead of showing you the same table with different numbers all over again, we want you to look at this chart and think for a second:

Dollar-Cost Averaging Index Example

What’s the overall direction? 

The answer is simple: Up.

The above chart belongs to none other than the S&P 500, the index that tracks the top 500 large-cap companies in the United States stock market.

Without diving too much into details, remember that an index is just a measure, to actually invest in it we need to use funds, etfs, futures, etc. What we really care about here is understanding the power of diversification for a Dollar-Cost Averaging investor by comparing the S&P 500 against individual assets.

In 2018:

And the S&P 500?

Well, it merely brushed off a few points from 2695 to around 2500.

Case completed, and always remember:

Dollar-Cost Averaging Vs. Lump Sum Investing (Market Timing)

Lump sum investing is nothing more than investing at a single time a big amount of money whereas Dollar-Cost Averaging is about slowly diluting the invested amount over long periods of time.

Before we begin our comparison, please remember the following:

Great, so ,let’s compare what would have happened between the two approaches using data from one of our previous examples, Bitcoin:

As you can see, Lump Sum investing blows the returns of Dollar-Cost Averaging out of the water, but wait a second…. Does it?

In reality, it’s a matter of personal opinion since:

In conclusion:

Lump Sum investing beats the returns of Dollar-Cost Averaging assuming that the investor gets the timing right which means that there are higher risks associated with the first strategy in comparison to the second one.

How to invest using Dollar-Cost Averaging?

The first thing you’re very likely to need is a broker that allows fractional trading, which means nothing more than the ability to buy small fractions of an asset’s unit for example: 0.1 units of a Tesla share, 0.05 units of an Amazon share, etc.

Depending on your location there are several choices, for example:

Once you’ve got a brokerage account set up which is a fairly easy and straightforward process, the next steps are to sit down with pen and paper and think:

Our guide on how to buy stocks covers this decision making process very well, but to give you a basic overview, we recommend the following:

The frequency part is very interesting, you could end up choosing to:

The higher your frequency, then the more important it will become for you to have a 0 commissions broker, otherwise the cost in fees will be too high for your frequent strategy to be sustainable.

Now that you’ve got all the previous steps covered, it all boils down to your asset choices, and only you can answer this question:

Picking assets requires a complete guide, but you can find an amazing process described in our how to buy stocks guide to give you an idea of how to analyse a stock for example.

The rest is very simple, follow your strategy and don’t look back, only time tells if you’re right or wrong.

Good luck!

 

Frequently Asked Questions

For whom is Dollar-Cost Averaging best?

For investors that:

Does Dollar-Cost Averaging really work?

Yes, Dollar-Cost Averaging has proven to deliver amazing results when used correctly in well diversified assets such as ETFs or S&P 500 funds.

When used in high risk individual assets it can also be profitable but it requires far more analysis and care.

What is the best frequency for Dollar-Cost Averaging?

There is no optimum frequency for Dollar-Cost Averaging, it all depends on two factors:

A nice strategy used by many small investors is to use the money they planned to spend on entertainment on a daily basis on purchasing assets, but for this to work, a no commission broker is definitely a must have.

Author

Stefano Treviso

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