“There is simply no telling how far stocks can fall in a short period… your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.” – Warren Buffett, Berkshire Hathway 2017 shareholder letter
Dollar Cost Averaging (DCA). It sounds fancy, but it’s not complicated. The goal of DCA is to lower the cost per share while removing emotion from your investment decisions. So let’s get to it. Here are the top things you should know about DCA.
1) When to consider implementing DCA
Some of the scenarios that make sense to use DCA include those who:
- Have a long investment horizon
- Are in a volatile environment like the one we are seeing related to COVID
- Want to eliminate risk from their investment strategy
- Don’t have a lump sum to invest
- Want an easy way to consistently invest
- Hoarded cash due to a black swan event and need a way to re-enter the market
2) How DCA Works
During volatile times like these, DCA has the opportunity to shine. By consistently investing the same amount of money on every transaction, DCA ensures you buy more shares at the low and fewer shares at the high. For example, let’s assume you make $1,000 purchases monthly for 6 months:
|Cost/Share||Amount Spent||# of Shares Purchased|
Total Spend: $6,000
Total Shares Purchased: 117
Because of DCA, you bought more shares at the low (i.e. month 1 and 6), and fewer shares at the high (i.e. month 4). If you had made a lump-sum investment in Month 2, 3, 4, or 5, you would have paid more per share than if you had implemented the above strategy. Of course, if you had made a lump-sum investment in Month 1 or 6 you would have paid less per share. Timing the market just right for a profitable lump-sum purchase can be extremely hard to do without a crystal ball. Also, not everyone has a lump sum readily available to make an investment. With DCA you can “set it and forget it”, allowing you to consistently invest and increase your likelihood of reducing the cost per share over time.
3) How to implement DCA
If you are already contributing to a group retirement plan at work, good news! You are already Dollar Cost Averaging. Likely every pay period you are making a retirement savings contribution, which by definition is DCA.
If you are looking to utilize DCA outside of a group retirement plan, there is not a required frequency nor a minimum investment to utilize DCA. Many choose to make monthly transactions. Another common strategy is to make transactions every pay period (forcing you to pay yourself before anyone else). This can be set-up so that the withdrawals are made automatically out of your account. Work with your financial advisor to decide what stocks and/or bonds to purchase.
4) What to avoid when using DCA
Warning: Do not stop investing when the market is down. One of the advantages of DCA is removing the emotion from your investment strategy. When the market is down, you acquire shares at a lower cost, and that’s what makes DCA work in the long run.
Also, DCA can get pricey if you are being charged for every transaction. Make sure you understand any possible fees associated with this strategy. At our firm there are no transaction costs for dollar cost averaging.
Lastly, if you have the money to make a lump-sum investment, work with your advisor to consider the pros and cons vs. dollar cost averaging. Although dollar cost averaging can be a good strategy to implement, it’s not always the best solution depending on your specific situation and the current market.
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*Investing regular amounts steadily over time (dollar-cost averaging) may lower your average per-share cost. Periodic investment programs cannot guarantee profit or protect against loss in a declining market. Dollar-cost averaging is a long-term strategy involving continuous investing, regardless of fluctuating price levels, and, as a result, you should consider your financial ability to continue to invest during periods of fluctuating price levels.
**Examples are hypothetical and for illustrative purposes only. The rates of return do not represent any actual investment and cannot be guaranteed. Any investment involves potential loss of principal.
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