How a Dollar-Cost Averaging Investment Strategy Can Make You Money

When it comes to building wealth, investing has the most potential for growing your net worth over time. And, how your portfolio will perform will depend on the strategy you use. There are lots of investing strategies—and there’s no one-size-fits-all template to follow. So, what can you do?

Dollar-cost averaging (DCA) can be a smart money-making method of investing. It takes a long-term view of the investment market and can take the angst and guesswork out of decision-making.

What is Dollar-Cost Averaging (DCA)?

No one has an economic crystal ball. And, when it comes to choosing what to include in your portfolio, it can be hard to try to:

• forecast changes in the economy and new consumer trends
• predict the effect those changes may have on the stock market
• identify the best investments to make for now and the future
• choose the best time to invest

To offset the uncertainties, you can invest a set amount at regular intervals, regardless of how stock prices change--that's dollar-cost averaging.

One example you’re probably familiar with is a retirement account. You contribute the same amount every month, no matter what’s happening in the market. Over time, between your contributions and your investments’ growth, typically your retirement fund will grow.

But, you’re not restricted to using dollar-cost averaging for retirement accounts only. It can be used for just about any stocks, mutual funds or exchange-traded funds (ETFs) as well.

How Does Dollar-Cost Averaging Work?

Suppose you decide you can invest $100 a month. Then, you pick a stock, mutual fund or ETF that’s currently $10 a share.

Month 1: In the first month, you’d be able to add 10 shares to your portfolio.

Month 2: What if the price for that stock drops to $5 a share in month 2? You’d be able to add 20 shares for the same $100.

Month 3: Now, let’s assume the price goes back up to $10 a share in month 3. You’d add 10 shares. Here are the results:

Based on the price fluctuations, you now have 40 shares in your portfolio instead of 30. Your average cost for those 40 shares after 3 months is $7.50 per share. That’s the power and value of dollar-cost averaging.

We used this hypothetical example purely to illustrate how dollar-cost averaging works. In real life, you’d want to track your investments for longer than just 3 months. You wouldn’t be investing in just 1 stock. And if, for example, share prices rose to $12 in a month before leveling out at $10, that would increase your average cost.

Are There Avantages to Dollar-Cost Averaging?

Keeping track of changes in the market is very difficult, even for professional investors. Using this method is much easier than watching what’s happening, while trying to “time the market” for the best price per share. All you need to do is to invest the same amount on a regular schedule. Using dollar-cost averaging:

• minimizes your risk: If you made a single lump-sum investment and prices fell, you could experience losses. But, since you’re spreading out your investment dollars, you’re not likely to invest everything at a bad time and less likely to suffer significant losses.
• takes anxiety out of the equation: Watching market fluctuations can be distressing, especially for new investors. And, it’s easy to get confused over whether you should follow the latest trends and invest in hot new stocks. Using dollar-cost averaging removes the anxiety and frustration components of choosing the right time to invest. It also prevents impulsive investment decisions based on short-term market movements. Instead, you’ll stick to a predetermined, steady investment schedule.
• helps average out purchase prices: Implementing a dollar-cost averaging strategy allows you to buy more shares when prices are low and fewer shares when prices are high. Over time, this averaging effect can lead to a lower average price per share.
• simplifies investing: Dollar-cost averaging is a straightforward investment strategy that doesn’t require constant monitoring or complex decision-making with every share purchase. That’s why many people new to investing or those who simply have no time or desire to watch the market use this method.

The stock market generally increases over time. You'll still need to be aware of how your investments are trending, and check for any occasional rebalancing needs. But overall, you can take it easier knowing your investments are in it for the long-haul.

Are There Disadvantages to Dollar-Cost Averaging?

Nothing in life is 100% perfect, and that includes dollar-cost averaging. Some potential downsides are:

• realizing slightly less growth. According to a recent Vanguard study, dollar-cost averaging portfolios realized returns that were slightly lower than investing a lump sum—68% of the time. For example, suppose you had a large lump-sum amount to invest, like from an inheritance. Since the stock market tends to trend upward over time, if you invested the whole amount when prices were low, your portfolio probably would do better than if you held onto it and slowly invested it in smaller amounts. That said, according to the Vanguard study, lump-sum strategies had “greater losses in some of the worst market environments.”
• not eliminating risk completely. No investment is 100% risk-free. The market changes quickly and sometimes dramatically. If you just set up your schedule and never look at your portfolio again, you could miss noticing the poor performers. That could cost you. So, you still need to review your portfolio periodically.
• missing out on opportunities. By following a set schedule, you could miss out on opportunities to buy low if they arise after you’ve already spent your regular investment dollars. Plus, you could end up with fewer shares than you might have had if you’d been able to jump on those opportunities.

How Can You Set Up Dollar-Cost Averaging for Your Investments?

Creating your own dollar-cost averaging strategy is fairly straightforward.

1. Determine how much you can comfortably afford to invest. Decide how often you’ll invest. Your schedule could be weekly, monthly or whatever makes sense for you.
2. Choose where you’ll invest. Will you include stocks, index, exchange-traded or mutual funds or a mix? Consider your long-term goals and risk tolerance when deciding the best way to invest your money.
3. Automate your investments. This will simplify the process and remove the temptation to spend the money or panic buy or sell. Navy Federal members can set up automatic transfers from their checking or savings accounts to their investment accounts.

Keep in mind that you still should review your portfolio regularly and make adjustments when necessary. And, if you experience a change in your circumstances, like getting married or divorced, adding a family member or a change in employment, your strategy may need to change as well.

When is the Best Time to Invest?

With dollar-cost averaging, the best time to invest is on a consistent schedule, like weekly, every other week or monthly. Investing regularly, regardless of market conditions, means you’ll spread out your investments and reduce the impact of short-term market fluctuations. For many investors, aligning investments with their pay schedule—like every 2 weeks when they receive their paycheck—is an effective way to maintain a disciplined investing routine.

What If You’re Still Not Sure About Your Investing Strategy?

Consider using an online investing tool. If you’re looking to simplify the investing process, our Digital Investor is a powerful online investing tool. And, with Digital Investor, you have choices. You can manage your own investments or choose prebuilt bundles. Or, we can create, diversify and manage an automated portfolio for you—based on your finances, goals and risk tolerance. We’ll even rebalance it for you from time to time, based on market conditions and your preferences.

Consider consulting an advisor. If you’re interested in human guidance, Navy Federal Investment Services financial advisors are licensed investment professionals. They can help you develop an investment strategy that makes the most sense for you. They’ll take a comprehensive look at your overall finances and help you with a plan to achieve all your financial goals. Plus, if you’d prefer a more hands-off approach to investing, they can even manage your portfolio for you. And, best of all, your first consultation won’t cost you anything. You can find an advisor near you by visiting our financial advisor locator page.