Reduce risk with dollar-cost averaging
Investing money in a stock or fund systematically instead of all at once can help smooth out your purchase price.
January 25, 2024
We explain what dollar-cost averaging is and why it can be a useful investing strategy for reducing risk, then walk through an example of how it works.
What is dollar-cost averaging?
Dollar-cost averaging (DCA) is a strategy where you invest a set amount of money in the same stock or fund systematically over a period of time. Rather than investing a large amount all at once, you break it down into smaller amounts to invest on a scheduled basis. This helps you invest at various prices instead of trying to choose “the right day.”
Dollar-cost averaging as risk management
Investing smaller set amounts over time smooths out your average purchase price because you buy when prices are both higher and lower. DCA also takes the emotion out of investing since you invest at scheduled times without having to decide when. During periods of market volatility, this can be a helpful strategy to reduce risk.
Examples of DCA in action
Making regular payroll contributions into an employer-sponsored retirement plan (like a 401(k)) is a common example of dollar-cost averaging.
Here’s another example that helps illustrate how DCA works: Let’s say you want to invest $3,000 in a specific mutual fund. Instead of doing it all at once, you invest $1,000 on the 1st of each month for 3 months.
How it works
In Month 1, maybe the fund’s share price is $25 and you are able to buy 40 shares for $1,000. The next month, maybe the shares are $20 each and you can buy 50 shares with your $1,000. In Month 3, maybe the price remains at $20, so you get 50 more shares with your last $1,000.
Using dollar-cost averaging, over the 3 months you purchased 140 shares at an average price of $21.43 per share. But, if you’d invested the entire $3,000 in Month 1, you’d only own 120 shares and would’ve spent $25 per share.
Long-term goals in mind
The goal of dollar-cost averaging is to prevent you from potentially making a badly timed lump-sum investment at a higher price. It’s a popular strategy for those new to investing, and it can allow you to build wealth slowly but surely.
Dollar cost averaging and automatic investing
A simple way to put DCA into action is to set up automatic investments. Whenever you buy a stock or fund with Plynk, you have the option of making a one-time purchase or monthly recurring investments.
Read more: How to set up automatic investing.
Next steps to consider
Need help finding investment ideas? Try Plynk Explore.