Dollar Cost Averaging (DCA)

Dollar cost averaging (DCA) is an investment method in which a fixed amount of money is invested at regular intervals, such as every month, regardless of the price of the investment at the time. Because the amount is fixed, the investor automatically buys more shares or fund units when prices are low and fewer when prices are high. It is widely used by savers who invest from each pay cheque, especially through workplace pension plans, mutual funds and exchange-traded funds.

Outside the United States the same method goes by other names: "pound cost averaging" in the UK, and the systematic investment plan (SIP) offered by mutual fund companies in India and Pakistan, where a fixed sum is debited from a bank account each month and invested in a chosen fund. DCA is often compared with lump-sum investing and is sometimes confused with market timing, which it deliberately avoids.

Imagine filling a car with the same $50 of fuel every week instead of filling the tank to the brim. When fuel is cheap, $50 buys more litres; when it is expensive, it buys fewer. Over a few months, the average price paid per litre ends up slightly below the simple average of the pump prices, because more litres were bought on the cheap days.

Dollar cost averaging applies that habit to investing. The saver does not have to guess whether today is a good day to buy. The fixed amount goes in on schedule, rising and falling prices balance out over time, and the decision becomes a routine rather than a bet.

The average cost per unit under DCA is the total amount invested divided by the total number of units bought:

• $\bar{C}$ is the average cost paid per unit.
• $A$ is the fixed amount invested each period.
• $P_i$ is the price per unit in period $i$.
• $n$ is the number of periods.

The result is the harmonic mean of the prices, which is never higher than their simple average. Suppose an investor puts $300 a month into a fund for three months at prices of $10, $6 and $12:

• Month 1: $300 ÷ $10 = 30 units.
• Month 2: $300 ÷ $6 = 50 units.
• Month 3: $300 ÷ $12 = 25 units.

The investor has spent $900 and owns 105 units, so the average cost is $900 \div 105 \approx 8.57$, or about $8.57 a unit. The simple average of the three prices is $(10 + 6 + 12) \div 3 \approx 9.33$, or about $9.33. At the month-3 price of $12 the holding is worth $1,260, a gain of $360 even though the price ended only 20% above where it started.

When an investor already has a large sum, the question is whether to invest it all at once or feed it in over months. Because markets have risen more often than they have fallen over long periods, studies generally find that investing a lump sum immediately produces a higher total return more often than not. A 2012 Vanguard study of US, UK and Australian markets found that lump-sum investing beat a 12-month DCA approach about two-thirds of the time. The cash waiting to be invested earns only cash-equivalent returns in the meantime.

DCA's case is behavioural and about regret. It reduces the chance of investing everything just before a crash, makes a fall in prices feel like an opportunity rather than a disaster, and suits people whose money arrives monthly anyway. Most salaried savers using a payroll savings plan, an IRA contribution schedule or a SIP are dollar cost averaging by default, because they invest as they earn.

• Automatic plans. Many fund companies let investors set up a monthly debit, often with a low minimum. Platforms for micro investing apply the same idea with very small amounts.
• Dividend reinvestment. Dividend reinvestment plans buy more shares with each payout, a form of averaging in.
• Crypto purchases. Some exchanges offer recurring buys of Bitcoin and other cryptocurrencies; the method does not reduce the asset's underlying risk.
• Value averaging. A variant in which the investor adds whatever amount is needed to keep the portfolio on a pre-set growth path, buying more after falls and less after rises.

DCA does not guarantee a profit or protect against loss in a falling market: if prices decline for years, every instalment loses value. It also does not make a poor investment a good one, and frequent small purchases can be expensive where each trade carries a commission or a sales charge. The method works best with diversified, low-cost funds held for a long time horizon, and should be judged against the investor's risk tolerance and overall asset allocation.

• U.S. Securities and Exchange Commission: Saving and Investing, A Roadmap to Your Financial Security
• Securities and Exchange Board of India (SEBI)