Is dollar-cost averaging risky?
Quick Answer
DCA is a good strategy for investors with lower risk tolerance. If you have a lump sum of money to invest and you put it into the market all at once, then you run the risk of buying at a peak, which can be unsettling if prices fall. The potential for this price drop is called a timing risk.
It keeps you open to opportunities. Market timing—trying to pinpoint precisely when the market will reach its peak or hit the bottom, and buying and selling accordingly—is almost impossible, even for professional investors. Dollar cost averaging helps ensure that you'll be at the door when opportunity knocks.
A Lump Sum investment into a 60/40 (stock/bond) portfolio has the same level of risk as Dollar Cost Averaging into the S&P 500 over 24 months, yet the Lump Sum investment is more likely to outperform!
Disadvantages of Averaging Down
Averaging down is only effective if the stock eventually rebounds because it has the effect of magnifying gains. However, if the stock continues to decline, losses are also magnified.
When you put all your money in at once, you're more likely to see results quickly. This can be a helpful motivator for a beginning investor. You will often see higher returns with lump sum investing compared to dollar-cost averaging.
But investors who engage in this investing strategy may forfeit potentially higher returns. With dollar-cost averaging, you're holding onto your money as cash longer, which has lower risk but often produces lower returns than lump sum investing, especially over longer periods of time.
“If you like spending six to eight hours per week working on investments, do it. If you don't, then dollar-cost average into index funds.” Buffett has long advised most investors to use index funds to invest in the market, rather than trying to pick individual stocks.
Dollar-cost averaging is a simple way to help reduce your risk and increase your returns, and it takes advantage of a volatile stock market. If you set up your brokerage account to buy stocks or funds automatically and regularly, then you can sit back and do the things you love, rather than spend your time investing.
That's still dollar-cost averaging. For those incorporating it into their monthly cash flow, such as contributing to their employer plan or Roth IRAs, the frequency is typically once a month.
Why do you think dollar-cost averaging reduces investor regret?
Dollar-cost averaging makes it easier to stick to the plan
In hindsight, after the market has recovered, investors often regret not taking advantage of what they now know to be a great buying opportunity.
Points to know
Dollar-cost averaging may spread the risk of investing. Lump-sum investing gives your investments exposure to the markets sooner. Your emotions can play a role in the strategy you select.
Investing a lump sum means that you don't have to try to figure out the best time to make periodic investments. You can set up your portfolio and let it grow. A 2021 Northwestern Mutual Life study showed that investing a lump sum generally outperforms dollar-cost averaging over various periods of time.
Most people earn money over time, and therefore must stick to a monthly investment schedule, that's fine. However, if you can make a lump sum, it is worth exploring the option. Making a lump sum investment is the most effective way to invest. This is because it maximises 'time in the market'.
You just pay more. But, if you invest the same amount of money in a year, there is no difference if you invest $250 a week or $1084 a month.
The best time to buy a stock is when an investor has done their research and due diligence, and decided that the investment fits their overall strategy. With that in mind, buying a stock when it is down may be a good idea – and better than buying a stock when it is high.
The data shows lump-sum investing often works in favour of investors. But if you are finding it hard to get back into the market, a DCA strategy can help you take that important first step. It can also provide a smoother investment experience.
The Best Day to Weekly DCA Bitcoin
Similar to the best time of the day to DCA, we also found a weekly pattern. Since 2010, Mondays have had the highest odds of having the weekly low price relative to the weekly high price falling on this day. This pattern holds up over the last 12 months.
Lump-sum investing may generate slightly higher annualized returns than dollar-cost averaging as a general rule. However, dollar-cost averaging reduces initial timing risk, which may appeal to investors seeking to minimize potential short-term losses and 'regret risk'.
Dollar cost averaging only leads to better returns when markets decline, yet ironically if markets are known in advance to decline, it would be better to wait to invest altogether, and still not dollar cost average!
Is dollar-cost averaging better than buying the dip?
Buying the dip only works if you know that you've reached the bottom of a decline, and you can time it perfectly. What's more, severe dips—where you stand to get huge returns—are rare events. Therefore, the strategy rarely beats dollar-cost averaging.
Dollar cost averaging (DCA) is an investment strategy that aims to apply value investing principles to regular investment. The term was first coined by Benjamin Graham in his book The Intelligent Investor.
Key Takeaways. Dollar-cost averaging is the practice of systematically investing equal amounts of money at regular intervals, regardless of the price of a security. Dollar-cost averaging can reduce the overall impact of price volatility and lower the average cost per share.
Many investors use dollar cost averaging as part of a passive investment strategy, meaning they invest in passively managed index funds that track an entire market. This reduces the amount of personal due diligence that's required from them compared to researching specific stocks or actively-managed mutual funds.
Dollar cost averaging is a strategy that can help you lower the amount you pay for investments and minimize risk. Over the long term, dollar cost averaging can help lower your investment costs and boost your returns.
