The benefits of dollar-cost averaging (DCA) are generally extolled by market commentators and investment providers. But this well-regarded strategy may not always be the best approach for individual investors.1
What is Dollar-Cost Averaging?
Dollar-cost averaging is the practice of buying a fixed-dollar amount of a particular investment on a regular schedule over a period of time. The primary advantage of DCA is that an investor buys fewer shares when the price is higher and more shares when the price is lower, which can mean a lower average cost over time. Keep in mind that DCA does not protect against a loss in a declining market or guarantee a profit in a rising market.
Here’s an illustration of how DCA would works for an individual who wants to purchase $1,000 of a particular investment for six periods.
|Ended||$9.83 Average purchase price||610.35 shares
This is a hypothetical example used for illustration purposes only. It is not representative of any specific investment or combination of investments.
As this example shows, the DCA strategy resulted in an average purchase price of $9.83 ($6,000 divided by 610.35 shares). By comparison, someone who invested the full amount at the first period would have purchased 600 shares for $10 a share.
Lump-Sum Investing vs. DCA
DCA is a strategy often suggested for investors with a lump sum who want to reduce the guessing game of trying to buy low and sell high.
In a landmark study, one mutual fund company found that investing a lump sum of money right away may be a better approach than investing that lump sum via a DCA strategy.2
Comparing the lump-sum investment (LSI) approach with a 12-month DCA strategy at varying asset allocations, the mutual fund company analyzed every rolling ten-year period from 1926 to 2011 to determine which strategy was most effective.3
Regardless of the allocation used, the LSI strategy in several instances performed better than the DCA strategy.4
For example, when invested 100% into stocks, the LSI outperformed the DCA in 66% of all the time periods. This outperformance was similarly achieved in a 60% stock, 40% bond allocation (67% outperformance in all periods) and 100% bonds (65% of all periods).2 Keep in mind that past performance does not guarantee future results.
This is not to suggest that DCA is a poor strategy. For individuals investing in their retirement money or looking to invest a regular amount each month from personal savings, DCA can be an ideal approach to building wealth over the long term.
1. Dollar-cost averaging does not protect against a loss in a declining market or guarantee a profit in a rising market. Dollar-cost averaging is the process of investing a fixed amount of money in an investment vehicle at regular intervals, usually monthly, for an extended period of time regardless of price. Investors should evaluate their financial ability to continue making purchases through periods of declining and rising prices. The return and principal value of stock prices will fluctuate as market conditions change. Shares, when sold, may be worth more or less than their original cost.
2. Vanguard, 2017.
3. Vanguard™’s calculations were based on benchmark data for the period January 1, 1926 to December 31, 2011. Standard & Poor™’s 90 (January 1926, February 1957), S&P 500 Index (March 1957, December 1974), Wilshire 5000 Index (January 1975, April 2005), MSCI U.S. Broad Market Index (May 2005, December 2011). Bonds: S&P High Grade Corporate Index (January 1926, December 1968), Citigroup High Grade Index (January 1969, December 1972), Lehman Brothers U.S. Long Credit Aa Index (January 1973, December 1975), Barclays Capital U.S. Aggregate Bond Index (January 1976, December 2011). Cash: Ibbotson U.S. 30-Day Treasury Bill Index (January 1926, December 1977), Citigroup 3-Month U.S. Treasury Bill Index (January 1978, December 2011.
4. Asset allocation is an approach to help manage investment risk. It does not guarantee against investment loss. Past performance does not guarantee future results.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG, LLC, is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright 2018 FMG Suite.