Dollar Cost Averaging

 

Does dollar cost averaging enhance portfolio returns ?

Dollar cost averaging is when you buy an investment on a regular basis no matter the price. This technique means you buy more shares when the market is down and fewer shares when the market is up. It’s no guarantee that you make money, but instead of investing one lump sum you can invest your money over a specific amount of time.

Another way to dollar cost average is to automatically set up monthly contributions in whatever your investment choice is stocks, bonds, ETF, mutual funds. Set a fixed dollar amount, say $XXX a month and purchase that amount the 1st of every month no matter what the stock market conditions are. It is a great way for younger investors, or those who do not have a lump sum to invest.

When we first started investing, we used dollar cost averaging and invested in mutual funds. We had money automatically coming out of our accounts every month, it was like forced savings. The only thing I would change now is I would use cheaper ETF instead of mutual funds. You can read my post In The Beginning.

Does dollar cost averaging enhance portfolio returns ?

There are downsides of dollar cost averaging. If you have a stock market bubble, or you are averaging into a position that experiences an increase in value, your average cost will be higher than it otherwise would have been if you purchased as one lump sum. Dan Bortolotti from MoneySense  wrote a great article on the cons of dollar cost averaging read here. Does Dollar Cost Averaging Work ? 

Final Thoughts

Dan’s article is correct if you have a lump sum you are better to just invest it as early as you can, because historically markets go up far more often than they go down. But for young investors who are trying to save a monthly contribution I think dollar cost averaging is the way to go. The real value of dollar-cost averaging is that investors don’t need to worry about investing at the top of the market or trying to determine when to get in or out of the market. Michael Kitces also wrote an excellent article how dollar cost averaging reduces your returns. Also check out the Word of the Week.

 

Comments

  1. I received a small inheritance and my financial advisor suggested we Dollar cost average and invest it 25% every 3 months and be fully invested after 1 year. It is now fully invested. Thanks for your article I will read your links.

    • Thanks for the comment Maria. I like the idea of quarterly installments if I had a lump sum to invest. I am not very good at timing the market and if I invested a lump sum I am sure the next day the market would crash.

  2. I also find that setting up an automatic investment plan and buying irrespective of what the market does, subdues the temptation to time the market. It also counters recency bias and several other behavioral anomalies that wreck a good investing plan.

    • Thanks Enoch. I agree pay yourself first(automatic investment plan) and don’t try to time the markets.

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