What is Dollar Cost Averaging: How to use the strategy to build wealth over time

Are you looking to build wealth over time but don’t know where to start? Dollar cost averaging may be the strategy for you.

In this post, we breakdown what is dollar cost averaging (DCA), the benefits of dollar cost averaging, the cons and how will it perform in a bull, bear and sideways market.

Read on to find out if DCA is suitable for you!

What Is Dollar Cost Averaging?

Dollar-cost averaging is an investing technique used to reduce the effects of volatility on stock prices. When an investor uses dollar-cost averaging, they invest a set amount of money into a security at regular intervals. This technique can be used in anything: stocks, mutual funds, ILPs, ETFs.

The goal of dollar-cost averaging is to reduce the impact of market volatility on an investment portfolio. By investing equal amounts of money at regular intervals, an investor can smooth out the effects of volatility and avoid wrongly timing the market. Over time, this technique can help to lower the average price per share.

For example, let’s say you are an investor who has $1,000 to invest in a stock that is currently trading for $10 per share. If you buy 100 shares all at once, your average cost per share would be $10. However, if you buy 10 shares at a time over 10 different intervals, your average cost per share would be lower. This is of course with the assumption that the market is volatile and goes up and down.

How Does Dollar Cost Averaging Work?

Theoretical example

In this example we see that the investor buys more shares when share prices are lower and fewer shares when share prices are higher. Overall the investor earns more than if he had utilised lump sum investment as a strategy.

Practical example

In a U shape market, DCA will yield better returns:

In a bull market, you earn less using DCA:

In a market downturn, you lose less using DCA:

While these graphs show the various market condition, it should be noted that it is highly speculative and difficult to predict the type of market beforehand.

Lump sum investment involves timing the market, and often, investors do not enter at the top or at the bottom. Investors react only after they witness a trend, which may cause them to miss the bottom of the trend.

What are the Pros and Cons of dollar cost averaging?

Pros of dollar-cost averaging

• Lowers the average cost of investing in a volatile market.
• It should be an automatic process with little action required from you, the investor.
• Eliminates timing the market – many traders only enter the market after the price has risen.
• It takes the emotion out of investing and helps you avoid making irrational decisions with your investments that could negatively impact your overall returns.

Cons of dollar cost averaging

• It can take a long time to build up a significant position in an asset if you are only investing a small amount of money at a time.
• In a Bull market, you may end up earning less than if you have invested lump sum
• Requires discipline to invest a fixed amount at regular intervals.
• DCA form of long-term investing strategy that may not be suitable if the time horizon is short

Is Dollar-Cost Averaging investment strategy a Good Idea?

So, is dollar-cost averaging a good idea?

It depends. If you’re the type of investor who tends to panic when markets are volatile, or do not have time and experience to manage your portfolio, dollar-cost averaging can help you stay disciplined and avoid making rash decisions.

However, if you’re comfortable with market fluctuations and have a shorter time horizon, there may be better ways to invest. However, these methods are extremely risky and require constant monitoring.

In general, we recommend newbies use dollar cost averaging as an easy way and safer way to invest compared to lump-sum investment.

DCA is a conservative investment strategy as it almost guarantees returns in a sideways and bull market while lowers the loss incurred during a bear market.

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Who Should Use Dollar Cost Averaging?

Here is a simple checklist to check if the dollar cost averaging strategy is suitable for you!

1. You are looking at long-term investments
2. You do not have time to monitor the market
3. You do not want to take high risks
4. You are unsure of the market conditions

If these you fit the criteria, then dollar-cost averaging is for you!

What is the best use of Dollar Cost Averaging?

Remember! Dollar Cost Averaging is a strategy that helps you with investing regularly in the long term. 

Dollar cost averaging can be used for a variety of investment vehicles such as stocks, bonds, funds and a variety of other types of securities.

Dollar-cost averaging works best for ETFs or funds. This is so as dollar-cost averaging is a long term investment strategy and funds typically have a long time horizon.

We advise you to utilise other strategies to complement this, such as creating a balanced portfolio using the core-satellite portfolio method or diversify by using different investment assets such as ETFs, ILP or endowment plans.

Are there better strategies than dollar-cost averaging?

There is no one-size-fits-all answer to this question, as the best strategy for investing will vary depending on each individual’s unique circumstances.

One strategy often compared with dollar cost averaging is lump sum investment. Which is to invest a large sum of money at one go. Lump sum investment is great if the investment vehicle guarantees returns or experience very little fluctuation. This includes buying bonds or endowment plans.

However, lump sum investment subject the investor to timing risks. One wrong investment decision can wipe out a significant part of your portfolio.

Instead, as an investor, you should carefully consider your goals and objectives before deciding on an investment strategy.

Additional Tips for growing your wealth over time.

Dollar cost averaging is a sound strategy for growing your wealth over time. By investing a fixed amount of money into a security or securities at fixed intervals, you can minimize the effects of market volatility and make your money work for you over the long term.

There are a few things to keep in mind when using this strategy:

– Make sure you are investing in a well-diversified mix of securities to reduce the overall risk of your portfolio.

– Be disciplined about sticking to your plan. You may be tempted to sell when the market is down, but remember that you are investing for the long term.

– Don’t be discouraged if the value of your investment fluctuates in the short term. Over time, the market has a tendency to go up, so if you stick with your plan, you should be successful in the long run.

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