Dollar-cost averaging: what it means, and will it help me through market volatility?

Why dollar-cost averaging can be a good investing strategy when markets are volatile

What do you do when you see an item go on sale at the grocery store? If you have space in the cupboard, you stock up. That same thinking can also apply to investing: if the company you like gets cheaper, you might load up your portfolio with new shares.

There’s one problem: it can be hard to know when a stock is on sale, especially during periods of market volatility. When the price of your favourite cookies drops, you get excited. Investors, though, tend to get anxious when the market falls, and don’t buy more stock when maybe they should.

Fortunately, dollar-cost averaging, or DCA for short, is a proven strategy that helps investors buy more shares of a company when they get cheaper, and fewer when they get more expensive, helping them ultimately purchase more stock at lower overall cost.

Here’s what you need to know about DCA and why it could be the right strategy to help you meet your financial goals.

What exactly is dollar-cost averaging?

DCA is essentially investing on a schedule. You always invest the same amount of money in certain stocks or funds at the same time – like once a month or once a quarter – regardless of fluctuations in price. Iconic investor Warren Buffett has long advocated for DCA as a way for investors to stay consistent with their wealth-building goals. While studies have also shown that investing a lump sum at one time can provide more investment growth, DCA lessens the risk that you will put that chunk of money into an investment at the wrong time, like right before a market crash.

Dollar-cost averaging during volatility: Is it a good idea?

No one likes investing in volatile markets, but it’s during these ups and downs that new opportunities arise. While buying stock during a market decline may feel risky, DCA allows you to buy more of a company you like at a lower price, which is a good thing if you’re a long-term investor. This strategy works because, historically, asset prices rise over the long term. The less you pay for a security, and the longer you hold it, the higher your potential return when you sell. Also, because DCA is a disciplined approach, it can relieve some of the stress of trying to figure out when to buy a security when markets are choppy.

Is dollar-cost averaging right for everyone?

There is no one-size-fits-all investment strategy, and that includes DCA. It can be a good strategy for those who don’t have a lump sum to invest, or for people who don’t want to time the market – which is extremely difficult to do. Since you can’t know when the market will rise or fall, it can make a lot of sense to contribute some of your income every month. (As the old investing adage goes, it’s not about timing the market, but about time in the market.)

However, DCA may not be as effective if you have a large sum of money to invest, such as a gift from a family member or proceeds from the sale of a big-ticket item like a vehicle or a home. That’s because you could end up having a large sum of money sitting in cash for an extended period of time. If you find yourself sitting on a pile of cash, you might be better off investing all the money at once.

How often should you use dollar-cost-averaging?

While there is no ideal investment interval, many people invest every few weeks or months. You could use this strategy to invest a portion of every paycheque, or at every other pay period. You can keep this strategy going for your entire life, too – it’s a disciplined approach that removes any emotions that might hinder you from reaching your investing goals.

By the numbers

Here is an example of how DCA works.

Let’s say you earn $5,000 every pay period and you put 5% ($250 pre-tax) for a total of $3,000 per year toward an all-in-one ETF, regardless of the price and what’s happening on the market. Here is how many shares you would hold at the end of the first year through DCA, compared to saving that money up and making a lump-sum investment each year.

Even though the value of the shares is virtually unchanged at the end of the period, by buying steadily over the year, you would have almost 27 more shares of the fund than if you’d invested your money all at once.

Of course, if the share price rose steadily over that same period, then the lump sum would be to your advantage. As you can see in the example below, using a DCA strategy when share prices are steadily rising will mean you’ll pay more for every share you purchase.

But remember that under this scenario, whether investing a lump sum or using DCA, we’re investing a predetermined sum. If you plan to make a subsequent investment, DCA will make it easier to invest since you only have to save smaller sums, plus it will help you avoid the temptation of trying to time the market.

Why dollar-cost averaging is worth a look

Consistency is the key to success in many parts of life, including investing, which is why DCA is so popular. Plus, many investors prefer a set-and-forget investment style that doesn’t require them to follow daily or weekly market moves. 

DCA is especially great for newer investors with smaller amounts of money to put away. Like most investment strategies, DCA isn’t for everyone, but if you’re a long-term investor who doesn’t have time to follow the markets daily, it could be a good fit for you.