Dollar cost averaging is the process of purchasing an investment on a regular schedule. An example is a 401(k), where an employee contributes the same amount each month.
There isn’t a financial advantage to a dollar cost averaging strategy, apart from the regularity of investing.
Instead, it brings psychological benefits and helps investors ride the ups and downs of the market without as much stress.
Recent market volatility has a lot of investors wondering how to minimize its impact on their portfolio. No one wants to see the balance on their accounts decline. One strategy that can help balance out the volatility is called “dollar cost averaging” (DCA), and it can provide benefits to any type of investor.
“We're often confronted with the question, ‘How do I get started investing?’” says Rob Haworth, senior investment strategy director for U.S. Bank. “You may have a lump sum of cash from the sale of a business or property and are looking to put the money into a diversified portfolio of stocks and bonds. Or you could have a form of continuous cash flow, such as savings from your paycheck, and you want to know how to help it grow. Dollar cost averaging can be a good strategy for both situations.”
Dollar cost averaging (or DCA investing) is the process of purchasing investments on a regular schedule instead of putting a large sum of money into the market all at once. The amount of money invested using this approach is usually smaller than a lump sum would be, but the contributions will build up steadily over time.
One of the most common dollar cost averaging examples is when an employee signs up for a workplace retirement plan, such as a 401(k). They agree to contribute a set percentage of their income into the retirement plan each pay period.
For a specific DCA investing example, someone making $150,000 per year who is paid twice a month would receive gross pay of $6,250 per pay period. If they allocated 10% of their pay to a 401(k), they would be saving $625 out of each paycheck. At the end of the year, they would have saved $15,000. The return on the funds inside of their 401(k) would fluctuate based on the market.
“You're putting a regular amount to work in the market over time without regard to price. Sometimes prices will be higher, sometimes they'll be lower, but you essentially continue to accumulate investments.”
Rob Haworth, senior investment strategy director, U.S. Bank
Interestingly, research has found that there isn’t a significant financial benefit of dollar cost averaging, such as earning an extra return, when compared to a lump sum investment. The biggest advantages to a dollar cost averaging strategy are the psychological benefits it can provide.
Dollar cost averaging can offer a variety of benefits, but there may be times when investing a lump sum into the market is the better choice. It’s important to work with a financial professional to determine the best tools and strategies for meeting your financial goals.
“Your financial professional will work with you to think about your cash flow needs and your ultimate financial goals, setting that ultimate strategic allocation,” says Haworth. “Then they can also figure out your path to getting there. Time in the market can matter more than trying to time the market.”
From working with a financial professional to investing online, learn more about your investing options.
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