Whether or not you should use dollar-cost averaging depends on your individual circumstances and financial goals.
How Dollar Cost Averaging Works in Practice #
Different Variations of DCA #
There are several variations of dollar cost averaging that investors may consider:
Time-Weighted DCA #
Invest a fixed amount of money at regular intervals, regardless of the price of the asset.
Investors who want a simple “set it and forget it” approach that reduces the impact of market fluctuations on the overall purchase price.
Value-Weighted DCA #
Invest a fixed dollar amount based on the value of the asset at the time of purchase.
- High price? Invest a smaller amount
- Low price? Invest a larger amount
Investors who want to buy more when prices are low and less when prices are high. See my article on Value Averaging for a deeper dive.
Risk-Adjusted DCA #
Adjust the amount invested based on the perceived risk of the asset.
- Less risky asset? Invest a larger amount
- More risky asset? Invest a smaller amount
Investors with diversified portfolios who want to weight their investments by risk tolerance.
Tactical DCA #
Incorporate market trends and economic indicators into decisions about when and how much to invest.
I use different S&P 500 levels as triggers. Use Fibonacci. For example:
- Invest 1/3 when S&P 500 hits 3600
- Another 1/3 at 3200
- Final 1/3 at 2800
More experienced investors who want to take advantage of market conditions while still maintaining discipline.
These variations of DCA involve more complexity and require more time and effort to implement than a simple DCA strategy. Carefully consider your goals, risk tolerance, and available resources before deciding which variation is right for you.
Rebalancing Your Portfolio #
Because asset prices fluctuate over time, the proportion of each asset in your portfolio may change as a result of DCA.
Example: If one asset increases significantly in price, it may make up a larger portion of your portfolio, while other assets shrink. This can make your portfolio unbalanced and potentially riskier than intended.
Periodically review and rebalance your portfolio to ensure it stays aligned with your risk tolerance and financial goals.
Rebalancing involves transaction costs (fees for buying and selling) which may impact your overall return.
The Pros and Cons of DCA #
1. Risk Reduction
By buying an asset in smaller increments over time, you reduce the impact of short-term price fluctuations on the overall purchase price. This helps reduce the overall risk of the investment.
2. Emotional Detachment
DCA helps you avoid impulsive investment decisions based on short-term market movements or emotions. By following a predetermined plan, you make more rational, long-term decisions.
3. Simplicity
DCA is a relatively simple strategy that’s easy to implement and manage. It requires minimal time and effort to set up and maintain—great for investors who don’t have time to actively manage their investments.
4. Potential for Better Returns
By investing a fixed amount at regular intervals, you may be able to buy an asset at an average price lower than the overall market price. This can potentially lead to better returns over the long term.
1. Opportunity Cost
By investing a fixed amount at regular intervals, you may miss the opportunity to buy an asset when it’s trading at a lower price. This can result in a higher overall purchase price, reducing potential returns.
2. Market Timing Risk
DCA relies on the assumption that the price will eventually go up, but there’s no guarantee. If the price declines instead of increasing, you may end up with a lower return or even a loss.
3. Transaction Costs
DCA involves making multiple purchases over time, which can result in higher transaction costs due to fees for buying and selling. This can eat into your overall return.
4. Limited Flexibility
DCA requires committing to a fixed amount at regular intervals, regardless of market conditions. This limits your ability to adjust your strategy in response to market changes or your own financial circumstances.
Quick Summary #
| Aspect | DCA Advantage | DCA Disadvantage |
|---|---|---|
| Risk | Reduces impact of volatility | Assumes prices will rise |
| Emotion | Removes impulsive decisions | Can feel frustrating in dips |
| Effort | Simple and automated | Multiple transactions = fees |
| Flexibility | Disciplined approach | Can’t easily adjust |
Conclusion: Should You Use DCA? #
Whether or not to use dollar-cost averaging is a decision based on your individual financial goals and risk tolerance.
- You want a simple, hands-off investment approach
- You’re investing for the long term
- You want to remove emotion from investing
- You have a regular income to invest consistently
- You have a lump sum to invest and believe the market will rise
- You want maximum flexibility to time the market
- Transaction fees are high relative to your investment amount
It can be a useful strategy for many investors, but it may not be the best option for everyone. Carefully consider the potential benefits and drawbacks before deciding.
Related: For a more active alternative to DCA, check out my article on Value Averaging—a strategy that forces you to buy low and sell high automatically.