What is Dollar Cost Averaging?

Dollar-cost averaging or DCA for short, is a blue print for investing in contrast to market timing. Investing an equal amount regardless of price at regular intervals, in theory, will allow you to realize a lower cost basis than you would have been able to achieve if you would had just dumped a lump sum of cash into the stock market on a single day.

For example, setting up an automatic investment of $500 a month in a Roth IRA on the same date every month would ensure the average price your paying is less than asset’s all time high due to poor market timing whilst maxing out the annual contribution limit of $6,000 for a Roth IRA.

For some months you’ll be buying high. While others you’ll be buying low as shown in the image above. However, averaging out the price you paid over the course of the year if the market is treading up, you’ll be riding the wave on a rocket to the moon.

If you would have invested the entire $6,000 in the S&P 500 on say Feb. 14, 2020, it wouldn’t be until Aug. 21, 2020 where you would break even from the pandemic low. With dollar-cost averaging instead of breaking even you would’ve made money.

Why it matters: Using the DCA technique ensures you’re not buying too much when the price is high while making sure you’re not missing out when the price is a bargain.

Key Takeaways:

• Dollar-cost averaging is a Set it and Forget it method that eliminates the FOMO anxiety when stocks are on a meteoric rise and the stress of panic selling when the market is crashing.

• For most people who know little about the stock market, you can’t go wrong using the DCA technique on a low-cost, no-commission, extremely diversified index fund that tracks the S&P 500.

• In the long run, investors using the DCA technique will lead to better results than trying to time the market due to human temptation of buying high and selling low.