What is Dollar Cost Averaging (DCA)?

Whether markets reach new heights or experience significant declines, investors often face a difficult decision: should they invest now, wait for conditions to improve, or hold off for a potential downturn?

The fear of "buying at the wrong time" is real, but staying on the sidelines can mean missing out on long-term growth. Rather than trying to predict the market, investors might consider Dollar Cost Averaging (DCA)

What is dollar cost averaging?

Dollar cost averaging is an investment strategy where you divide your total investment amount into smaller, regular contributions over time. Instead of investing a lump sum all at once, you invest the same fixed amount at regular intervals, regardless of market fluctuations.

By investing consistently, DCA mitigates the impact of market volatility. This approach allows you to buy securities, purchasing more when prices are low and less when prices are high, resulting in a balanced average cost. You are essentially engaging in DCA, if you for example invest a percentage of your monthly salary.

When should I use DCA?

DCA works well in various market conditions, making it particularly valuable in the following scenarios:

When markets reach historical highs: If you fear buying at the top, DCA allows you to invest gradually rather than all at once.
When markets are down or volatile: DCA allows you to take advantage of lower prices, potentially enhancing returns when markets rebound.
When you have a lump sum to invest: Dividing your lump sum into smaller, regular investments can make you more comfortable in uncertain market conditions.

DCA is versatile and can be effectively applied to stocks and ETFs, fitting seamlessly into various investment portfolios.

How does it work?

To understand how DCA works, consider this simple example:

Imagine you have EUR 12,000 to invest in a stock or ETF.
Instead of investing the entire amount immediately, you decide to invest EUR 1,000 each month for 12 months.

Since you can only purchase whole shares, any remaining balance is carried over to the next month. Here's how it might unfold:

Month	Share Price	Amount Invested	Number of Shares	Remaining Balance
1	100	1,000	10	EUR 0
2	95	1,000	10	EUR 50
3	90	1,050	11	EUR 40
4	105	1,040	9	EUR 95
5	110	1,095	9	EUR 105
6	100	1,095	10	EUR 95
7	98	1,095	11	EUR 13
8	95	1,013	10	EUR 63
9	90	1,063	11	EUR 53
10	85	1,053	12	EUR 33
11	88	1,033	11	EUR 45
12	92	1,045	11	EUR 43

Summary:

Total invested: EUR 12,000
Total shares purchased: 125 shares
Remaining cash: EUR 43 (at year-end)
Average cost per share: EUR 96.00

If you had invested the entire EUR 12,000 at the beginning of the year when the share price was EUR 100, you would have purchased 120 shares. But by using DCA, you bought more shares during market dips, ending up with 125 shares at a lower average cost of EUR 96.00.

Advantages and disadvantages

Like any investment strategy, DCA has strengths but also limitations:

Advantages of DCA
- Reduces the risk of poor timing by spreading investments over time.
- Decreases stress by eliminating the need to predict short-term market fluctuations.
- Makes investing easier, especially during uncertain or volatile market conditions.
- Can be automated, creating a "set and forget" approach.
Disadvantages of DCA
- If markets rise steadily, investing a lump sum from the start can yield higher returns.
- Requires patience, as your investments only gradually enter the market.
- If markets tend to rise regularly, investing all at once generally outperforms DCA.

How does DCA compare to lump-sum investment?

A common debate among investors is whether it's better to invest a lump sum all at once or stagger investments using DCA. Research shows that lump-sum investing often outperforms DCA in markets that tend to rise regularly.

However, DCA excels in managing investor risks and emotions. If market volatility or timing concerns make you anxious, DCA allows you to regularly participate in market growth while minimizing exposure to significant downturns.

Lump sum investing in worst-case scenarios: Investing a lump sum at market peaks, such as in 2000 or 2007, can result in prolonged recovery periods before regaining initial value. Conversely, using a DCA strategy allows you to purchase shares at a lower average price over time, potentially mitigating the impact of market volatility, and reducing the risk of investing at a peak.