What Dollar Cost Averaging Means for Your Financial Plan (2024)

Hi everyone! Welcome back to Melissa Making Cents!

Being a CERTIFIED FINANCIAL PLANNERTM, I learn all sorts of interesting facts and tidbits about finance that may not be known to everyone. I also have a lovely opportunity to meet all kinds of interesting people from various walks of life. When I meet these people, I love to learn all about their job(s) and how it's done. I'd like to think that most people are similar in my love for learning. That's one reason that I'm so passionate and dedicated about bringing yourealinformation that can positively impact you and your family through mediums like this blog!

Bringing you information that's pertinent to your life and your financial plan, I feel it, is a part of my job. Some of my focus as a financial planner are College Planning and Student Loan Advising after-all, so Idofeel strongly that education is essential and invaluable. I've gone on this long rant about education and making information about financial planning accessible because today, I'd like to focus on a subject and strategy that often goes overlooked but is often used by investors and money managers. The strategy I'm speaking of is called Dollar Cost Averaging, and if you're involved in any part of the investing process (from funding to managing), this subject needs to be on your radar.

What is Dollar Cost Averaging?

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Before I talk specifically about Dollar Cost Averaging, what it is, and how it works, I'd like to address something that's somewhat of an elephant in the room. Learning and educating (especially self-educating) about finance can be daunting; kudos to you for taking the time to better yourself through learning. However, while something like Dollar Cost Averaging doessoundcomplicated, challenging, and out of reach, it's really not as daunting a subject as it appears. In fact, Dollar Cost Averaging is something that's extremely basic, and many people use this strategy without even realizing they're doing so. What they often don't understand, however, are the underlying benefits of utilizing Dollar Cost Averaging. (Rant Over)

So, again, what is Dollar Cost Averaging?Dollar Cost Averaging is the strategy of investing consistent and incremental amounts of money in the same share over time. That's precisely what it is, plain and simple. So, we're done, right? Of course, we aren't done, silly! Though that's a reasonable definition of what Dollar Cost Averaging is, it might not make the most sense, so let's approach it from another direction.

If you absolutely hit the million-dollar jackpot, what would you do with it? Many things come to mind for most people, but one of the most common answers to this question that I hear is "INVEST"! Money makes money, so you'd want to invest all million dollars immediately, right? Well, not exactly. There's a fundamental issue with investing money into the market, and that's a lack of ability to look into the future. AKA, we know what the market did yesterday, we know what it's doing today, but we can only predict what it will be doing tomorrow. This lack of knowledge creates an issue with investing - we don't know that we're getting the best "bang for our buck" when we're investing in shares.

Using Dollar Cost Averaging, we take away some of the risks of overpaying for shares. By investing the same amount of money consistently and regularly, we're minimizing risk by distributing purchasing over a more extended amount of time. See, when we use Dollar Cost Averaging, we're spending the same amount of money every week, bi-weekly, or month. Because cost fluctuates, that means each period we invest, we'll purchase a different amount of shares. One crucial tenet of Dollar Cost Averaging is ignoring what is happening in the market and sticking to our plan regardless.

What are the Benefits to Reinvesting Dividends

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Last week in my article, Why Dividend Reinvestment can be An Important Part of Your Financial Plan, I talked about the benefits of reinvesting dividends. As a quick recap, reinvesting dividends means taking the dividends (or returns) and reinvesting them back into the same investment. By reinvesting your dividends, you're taking advantage of something called compound interest. Every time you reinvest your dividends, it means that your next dividend payout will be higher. This process snowballs and creates a lot of money out of what can start off from a meager investment.


The reason I bring up Dividend Reinvestment in this article about Dollar Cost Averaging is not only because the two work well in coalition with each other, but because when broken down, the principles behind their effectiveness are essentially the same! Because of terminologies and a few functional discrepancies, it can be difficult to understand, how similar the principles behind Dollar Cost Averaging and Dividend Reinvestment are.

Dividends are paid out on a regular and consistent basis, usually quarterly (four times per financial year). By reinvesting the money you earn from your dividends instead of pocketing it, you're participating in a form of Dollar Cost Averaging. You're (re)investing a consistent amount of money (your dividend) over a consistent period (quarterly or otherwise). Though your dividend's exact dollar amount may change, you're consistently reinvesting the amount paid to you. Doing this while simultaneously receiving the added benefit of incentive programs, like DRIPs (Dividend Reinvestment Plans), is making the absolute most out of your money while lowering the average cost of how much you're spending per share over time. Similar to Dollar Cost Averaging, by reducing your average cost per share, you're also minimizing your risk and maximizing the likelihood of your potential return on investment.

When discussing the similarities surrounding Dollar Cost Averaging and Dividend Reinvestment, people can often get hung up on the fact that the exact dollar amount of a dividend may vary or be confused by the time consistency of dividend payouts. If you're having trouble understanding how Dividend Reinvestment and Dollar Cost Averaging work so well together and operate using the same philosophy, I'd be happy to help you. Please feel free to contact me bygiving me a call or reaching out through our website.

Varying Asset Prices Can Equal A Lower (Average) Cost

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When we're using Dollar Cost Averaging, we're basically attempting to mitigate our risk of over-paying. Over-paying can be a real pain when you're investing for a few reasons. For starters, you're just not getting the best deal you can get, and we all know that's not a good feeling. When it comes to investing, not getting a great deal isn't only not a good feeling, it can end up COSTING you money if what you're buying into doesn't perform. That's a risk, and if you're investing a ton of money lump-sum, you're truly susceptible to that risk. On the other hand, Dollar Cost Averaging mitigates that risk over a consistent and longer period of time.

Wait, but doesn't buying, no matter the market, mean that I'll over pay for my shares?It does, but it also means that you'll underpay for them too. Because we can never accurately know in the present if prices are too high or not, we're at risk of over-paying every single time we invest. What dollar cost averaging does is ensure that you're not over-paying for all of your investment by spreading it out when you buy.

Why Not Just Time the Market?

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Timing the market is a dangerous game. Like I said, every time that we invest, there's a risk that we're over-paying. Suppose you have one hundred dollars to invest, and you purchase one share for one hundred dollars. Now, suppose that the next month, when you have no money to invest because you spent all of it on that one share, the price of those shares drop to twenty dollars a share. While you shouldn't be losing money in the long-term because you're a good long-term investor, that means you're missing out on the opportunity to purchase those same shares at a steep discount.

What Dollar Cost Averaging Means for Your Financial Plan (5)


Now, let's consider another scenario. You have ten thousand dollars to invest total, and you decide you work with your CERTIFIED FINANCIAL PLANNER™ to come up with a plan of investing over the time frame in the example above. The first month the price of a share is one hundred dollars; the next month, it's seventy dollars, the third is ninety dollars, the fourth is eighty dollars, and the fifth is seventy dollars, and so forth. That means that with the same money over a longer period, instead of purchasing one share one time for one hundred dollars, you've stuck with your (incredibly volatile) investment through thick and thin and spent the same amount of money on two and a half shares. Now, this is an example using imaginary numbers. Still, you can see that over time, the average of your purchases could be significantly discounted.

Is Automation a Smart Way to Go About Investing With Dollar Cost Averaging?

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At the risk of being too blunt, most people's issue with investing is that they get in the way of their own potential. A common newcomer's mistake is that when the market is down, they're overcome with panic and feel the need to immediately pull all of their money out of the market. This isnota good strategy. If you pull out all of your money when the market dips, you're ensuring that you'll experience a loss or your investment will not live up to its full potential.

The philosophy of Dollar Cost Averaging partially alleviates this bad habit. Monthly, weekly, or bi-weekly (or however else you prefer to schedule), you invest a specific dollar amount like clockwork. You don't micro-manage your funds/account; you just continue. Being in that mindset will take away a portion of the temptation to pull all of your money out when the market dips, as it regularly does. Unfortunately, the temptation is still there to pull out our money, but we can further dampen that temptation through automation! With automation, your money is invested automatically depending on your schedule or trigger event - like getting a paycheck. This allows your money to work for you while focusing on important things, like your job, friends, and family.


Automation, while incredibly helpful, can be difficult. I highly recommend talking to and working with your financial planning professional to set up an intelligent plan and have him or her help you with the automation process.

A CERTIFIED FINANCIAL PLANNER™ Can Create a Comprehensive Financial Plan To Help You Take Advantage of Dollar Cost Averaging

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Dollar Cost Averaging, Dividend Reinvestment, and Financial Automation aren't incredibly complex concepts when they're broken down into understandable bits. Anyone can understand why they'd want to mitigate risk over time and maximize the chances of their investments succeeding. Still, I know that at times financial jargon can be overwhelming and confusing to people who don't deal with it on a day to day basis. People like me are here to help bridge gaps. I connect people with ideas that will help them succeed. I help them understand how principles work together and relate to one another. Most importantly, I bridge the gap between where people are in their financial life and where they'd like to be. By connecting all of these ideas, people, and principles, I'm doing a small part in helping people and their families become educated and work their way towards financial success.


If you have questions or concerns about Dollar Cost Averaging, Dividend Reinvestment, or automation,please give me a call. As a CERTIFIED FINANCIAL PLANNER™, I work with people to help create custom financial plans to meet their needs and their families' circ*mstances. I can work with you to help you understand all of the principles and how they will positively impact your situation. Visit ourClient Service Experience Pageto see how we can help!

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Until next time, this is Melissa Making Cents.


Melissa Anne Cox CERTIFIED FINANCIAL PLANNER™ is also a College Planning and Student Loan Advisor and a Financial Coach in Dallas, Texas.

What Dollar Cost Averaging Means for Your Financial Plan (2024)

FAQs

What Dollar Cost Averaging Means for Your Financial Plan? ›

Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

What does dollar cost averaging help you with? ›

The dollar-cost averaging method reduces investment risk, but it is less likely to result in outsized returns. The advantages of dollar-cost averaging include reducing emotional reactions and minimizing the impact of bad market timing.

How often should you dollar cost average? ›

What is dollar-cost averaging? Dollar-cost averaging is the practice of putting a fixed amount of money into an investment on a regular basis, typically monthly or even bi-weekly. If you have a 401(k) retirement account, you're already practicing dollar-cost averaging, by adding to your investments with each paycheck.

How safe is dollar cost averaging? ›

Dollar cost averaging is a simple investing strategy that assists in mitigating market timing risk and can help you gradually accumulate wealth. Like all investing strategies, dollar cost averaging does not guarantee profit, but over time, can help in reducing the effect of market fluctuations.

Is it better to DCA or lump sum? ›

The lump-sum strategy came out on top in each time period. This is because markets generally rise over time. So the DCA investor often bought in at higher average prices. While this data is helpful, many of us do not make decisions based solely on stats and figures.

What are the 3 benefits of dollar cost averaging? ›

Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

What are the two drawbacks to dollar cost averaging? ›

Cons of Dollar Cost Averaging
  • You Could Miss Out on Certain Opportunities. Investing in the same stock or fund every month could cause you to miss out on other investment opportunities. ...
  • The Market Rises Over Time. ...
  • It Could Give You a False Sense of Security.
Sep 12, 2023

Why i don t recommend dollar-cost averaging? ›

But investors who engage in this investing strategy may forfeit potentially higher returns. With dollar-cost averaging, you're holding onto your money as cash longer, which has lower risk but often produces lower returns than lump sum investing, especially over longer periods of time.

When should I start dollar-cost averaging? ›

Even great long-term stocks move down sometimes, and you could begin dollar-cost averaging at these new lower prices and take advantage of that dip. So if you're investing for the long term, don't be afraid to spread out your purchases, even if that means you pay more at certain points down the road.

Is it better to invest all at once or monthly? ›

Research by Vanguard has found that lump-sum investing outperforms dollar-cost averaging 68% of the time. Dollar-cost averaging is the lower-risk option, and it's a good long-term investing strategy.

What are the disadvantages of dollar-cost averaging down? ›

Disadvantages of Averaging Down

Averaging down is only effective if the stock eventually rebounds because it has the effect of magnifying gains. However, if the stock continues to decline, losses are also magnified.

What is a downside of the share price dropping? ›

Key Takeaways. When a stock tumbles and an investor loses money, the money doesn't get redistributed to someone else. Drops in account value reflect dwindling investor interest and a change in investor perception of the stock.

How often should you buy stocks? ›

How often you invest, like your other investing decisions, ultimately comes down to personal preference and what you can comfortably afford to put aside for the long term (usually a minimum of five years). But we want to introduce you to a way of investing many choose to go for: regularly, each and every month.

Is dollar-cost averaging good for retirement? ›

Dollar-cost averaging offers the greatest benefit to investors who have a long-term investment horizon and can afford to be patient. Especially if they started such a discipline early on in life. If you don't have a long-term investment horizon, it may not be the best way for you to invest.

How much should I keep in cash vs investments? ›

Cash and cash equivalents can provide liquidity, portfolio stability and emergency funds. Cash equivalent securities include savings, checking and money market accounts, and short-term investments. A general rule of thumb is that cash and cash equivalents should comprise between 2% and 10% of your portfolio.

What is the best day to DCA? ›

The Best Day to Weekly DCA Bitcoin

Similar to the best time of the day to DCA, we also found a weekly pattern. Since 2010, Mondays have had the highest odds of having the weekly low price relative to the weekly high price falling on this day. This pattern holds up over the last 12 months.

Why i don t recommend dollar cost averaging? ›

But investors who engage in this investing strategy may forfeit potentially higher returns. With dollar-cost averaging, you're holding onto your money as cash longer, which has lower risk but often produces lower returns than lump sum investing, especially over longer periods of time.

How would you explain dollar cost averaging to a client and why is it important? ›

Dollar cost averaging helps investors become accustomed to fluctuations. “You're putting a regular amount to work in the market over time without regard to price,” says Haworth. “Sometimes prices will be higher, sometimes they'll be lower, but you essentially continue to accumulate investments.”

How to make money with dollar cost averaging? ›

How to Invest Using Dollar-Cost Averaging. The strategy couldn't be simpler. Invest the same amount of money in the same stock or mutual fund at regular intervals, say monthly. Ignore the fluctuations in the price of your investment.

What are the disadvantages of dollar cost averaging down? ›

Disadvantages of Averaging Down

Averaging down is only effective if the stock eventually rebounds because it has the effect of magnifying gains. However, if the stock continues to decline, losses are also magnified.

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