What is Dollar-cost Averaging?

Dollar-cost averaging

“How to get the best price for a stock/when to buy a stock?” has always been a mystery question when it comes to investing in stocks and as far as I know it is going to stay this way for a long time because we don’t know what news causes for the prices to drop and what causes them to grow. So to avoid paying more for a stock and buy the stock at best possible price at all times, we follow a strategy called Dollar-cost averaging.

What is Dollar-cost averaging then?

It is a strategy where a fixed amount of money is invested in buying the shares of a stock irrespective of the prices. The prices can go lower or higher than the current price but when invested in it for a long-term will give significant profits.

For example:

Months/InvestedAmount InvestedShare priceNo. of shares bought
Month 1$500$5010 shares
Month 2$500$5010 shares
Month 3$500$4012 shares
Month 4$500$2025 shares
Month 5$500$60~8 shares
Total amount invested: $2500Average price: $38.46Total shares: 65 shares
This is just an example of how calculation works and does not represent actual price

To calculate the average price of the share we use : Total amount invested/Total shares bought

So what happens if we try to time the market and buy the stocks only when the price is low. In that case you have to buy the shares during the month 4 when it is the lowest but we cannot know it before hand.

You might end up buying in month 5 which can incur loss or not as much profit as it might generate when you buy with the Dollar-cost averaging strategy.

Example: Assuming same total amount of $2500 and one time buy instead of consistent buying:

if you buy in 3rd month, you will end up getting the highest profit and hold 125(>65) shares of price

or if you buy in 5th month, you will have ~42 shares(< 65 shares) which is a loss compared to strategy-bought shares.

So it is recommended that we invest a fixed amount consistently in a fund that gives good profit in the long-term.

Pros are:

  1. You also don’t feel stressed buying a stock at its lowest price or keep checking when the market is down or up as most of us cannot handle a loss.
  2. It is easier to invest even for a beginner. All we have do is choose a fund initially and set up an auto-investing schedule that invests into the fund regularly. Thus also removing the feeling of guilt whenever we shop for our pleasure because your saving/investing part is already taken care of right after your salary is credited.

I hope this helps you in understanding the concept of Dollar-cost averaging without a hassle. Let me know your thoughts about it. Do you feel this is a good investment strategy? Let me know if you know any Cons of it.

To learn about it, please check below resources from which this article is researched:

  1. Dollar cost averaging by Charles Schwab
  2. Dollar cost averaging by Investopedia

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