Investing is a long-term game.
While you might be excited by Hollywood movies that show people buying and trading and making tons of money overnight, the reality is that being slow and steady with your investments will get you a lot farther than trying to time the market.
This is where dollar-cost averaging comes in. You invest the same amount of money each month, regardless of whether the market is up or down.
Sure, it's not flashy, but it's consistent, and that's what matters. This strategy also works especially well for small investors who don't have a large sum of money to invest all at once.
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What Is Dollar-Cost Averaging?
Dollar-cost averaging is an investment strategy where you consistently invest the same amount of money in the market, regardless of whether the market is up or down.
This means you'll buy fewer shares when the stock price is high and more shares when the stock price is low.
But over time, the cost of each share you add to your portfolio averages out, mitigating some risks that come with price volatility. It also reduces the need to actively manage your portfolio or think about market timing to get the best value.
Dollar-cost averaging helps to remove emotions from investing. You're less likely to jump on trends or panic sell, both of which can adversely impact the long-term growth of your portfolio.
Investing apps like Webull make it really easy to automate your investments with dollar-cost averaging. You can set up recurring investments in stocks and exchange-traded funds (ETFs) so that your portfolio grows consistently, without you thinking about it.
READ MORE: How To Start Investing
Benefits of Dollar-Cost Averaging
There are several reasons why dollar-cost averaging is a popular investing strategy. Here are some of the biggest benefits:
- More time for growth: Rather than waiting to invest a large sum of money when the market is just right, you spread your investment out. This gets your money invested sooner, giving you more time for compound growth.
- Builds strong habits: Dollar-cost averaging eliminates the temptation to spend money you've earmarked for investing.
- Low costs: Breaking up your investing into regular deposits makes it easier to get started, even if you only have $5 or $10 in your budget to invest with.
- Capture market fluctuations: When the market is up, you could use some of the gains to reallocate your portfolio into other assets. When it's down, you can purchase more shares at lower prices.
- Avoid emotional decisions: While staying informed about the market is important, you don’t have to try to time it. This can help mitigate some of the risks that come with market downturns.
RELATED: Active vs. Passive Investing: Which Is Best?
Drawbacks of Dollar-Cost Averaging
Dollar-cost averaging is great if you're establishing a new investing habit or want to invest small amounts of money.
There are some circumstances, however, where it might not be the best option.
- Not ideal for a lump sum: If you have a large sum of money — such as a bonus or an inheritance — it’s better to invest that money sooner rather than later, so you can start generating a return.
- Hard to reach fund minimum: Dollar-cost averaging is great for purchasing individual stocks, bonds, and ETFs, but it doesn’t work well for all securities. To invest in a mutual fund, for example, you’ll need a lump sum upfront because there is usually a minimum investment requirement.
- Miss short-term opportunities: With dollar-cost averaging, you may miss out on investing opportunities from emerging events like geopolitical developments, initial public offerings from promising tech companies, and other short-term trends.
- Easy to forget: If you want to set and forget your investments, dollar-cost averaging can be a double-edged sword. While it makes it easy to be consistent, it also makes it easy to forget about your portfolio. If you don't regularly check and rebalance your portfolio, you could be exposed to risks you hadn’t anticipated.
Examples of How Dollar-Cost Averaging Works
While dollar-cost averaging is an easy way to consistently invest, it can impact your portfolio differently depending on the state of the market.
Here are a few different examples to consider.
When the market rises
When the market rises, the value of stocks rises, too. While this is a good thing for someone who already owns stock, that’s not the case for someone who’s buying stock. Your investment will purchase fewer shares, which can reduce the overall value of your portfolio.
When the market falls
Declining markets mean that stocks have gone on sale. Because the average purchase price is lower, you can buy more. When the market goes back up, you have more shares in your portfolio to capture gains from.
When the market is flat
When the market is neither rising nor falling, you can still benefit from dollar-cost averaging. You’re still able to add shares to your portfolio and be prepared to generate a return when the market eventually goes back up.
FAQs
Can you do dollar-cost averaging with the S&P 500?
Following the S&P 500 is one of the easiest ways to implement a dollar-cost averaging strategy. You can regularly purchase shares of an ETF that tracks the S&P 500.
While there are some fees involved with ETFs, it eliminates the pressure of picking individual stocks.
Is it better to dollar-cost average or lump sum?
The investment strategy you opt for will largely depend on your personal preferences and circumstances.
If you have a lump sum of money to invest, then it might make sense to invest it all at once. This puts your money to work sooner rather than later.
Dollar-cost averaging is better if you don’t already invest consistently and want to get started. It eliminates some of the decision-making that goes into investing and distributes risk over a longer period of time.
TL;DR: Investing Through Dollar-Cost Averaging
Dollar-cost averaging is a strategy where you invest the same amount regularly, regardless of market conditions. This removes emotion from investing and helps you build consistent habits.
But if you do have a large amount to invest, don't wait just because you're using dollar-cost averaging. Put it all in at once instead of spreading it out to get your money working sooner.
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