Dollar Cost Averaging

Financial Dictionary -> Investing -> Dollar Cost Averaging

Dollar Cost Averaging (abbreviated as DCA) is a concept and technique which suggests that investing a small fixed amount at regular intervals in to the same investment is safer than investing one large lump sum. It spreads the market fluctuations out over several years so the total investment is not subject to one downturn or one upswing, but several over the years, averaging out the risk.

The theory is that investing a lump sum at once puts it at risk to the current market conditions, whereas gradually building up the portfolio insulates that risk by buying shares when prices are low, as well as high. Investors claim that in the long run it works out that you end up buying more shares at a lower price than at a higher price.

Although many investors may use this strategy without noticing, the method of using Dollar Cost Averaging simply involves deciding how much in total that you want to invest and how many months you want to make regular payments in to the investment. You obviously have to research your choice of investment and whether you are looking to buy stock, bonds, open a savings account etc.

An example of DCA in action is shown below:

Eric has $10,000 to invest in Microsoft, which he can invest right now, or over a period of time. He opts to invest $500 a month, over 20 months.

Right now $10,000 worth of shares would have purchased 300 shares at $33.33 each.

However after a few months the share price may have decreased and you would have purchased several shares at a lower price utilizing dollar cost averaging. If the share price picked back up by the end of the year you would have had more holdings than if you invested all at once.