What Is Dollar-Cost Averaging?

It's an age-old question: When is the best time to invest?

The answer is deceptively simple: when stock prices are low. However, trying to time the market—waiting for the best time to buy or sell an investment—is typically impossible even for professional investors. Fortunately, there's a time-tested strategy that can help you potentially lower the average cost of shares you buy through spreading your purchases out over time. It's called dollar-cost averaging.

Dollar-cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest, and potentially lower your stress level—as well as your average cost per share.

Let's say you invest $100 every month. When the market is up, your $100 will buy fewer shares, but when the market is down, your money will buy more. Over time, this strategy could lower your average cost per share compared to what you would have paid if you'd bought all your shares at once when they were more expensive than the average.

As you can see above, a dollar-cost averaging strategy enabled our hypothetical investor to take advantage of a price decline in Month 3, significantly reducing the average cost per share. Despite paying $4 or more per share in four out of the five months, the average cost per share came out to $3.70, and the investor was able to purchase a total of 135 shares.

By contrast, had all $500 been invested in Month 1, the average cost per share would've been $5 for a total of 100 shares.

In a perfect world, the investor would have invested all the money in Month 3 and walked away with 250 shares. However, there was no way of knowing ahead of time that this was the best time to buy, which is why dollar-cost averaging is so valuable. By investing fixed amounts frequently and regularly over a long period of time, you're less likely to miss out on those buying opportunities.

By the way, when you collect more shares of a stock by purchasing them on the way down, you're tracking the footsteps of Berkshire Hathaway (BRK.A) CEO Warren Buffett, who once said, "When we bought anything, we always hoped it would go down for a while so we could buy more."

While potentially reducing your cost per share is one compelling reason for dollar-cost averaging, there are other benefits to consider:

• It establishes good investing habits. Even though you know you should be investing regularly, sometimes it's tempting to spend the money earmarked for investing on other things. If you set up regular, automatic contributions, you're less likely to miss the money you invest, more likely to develop investing discipline, and more likely to stick to your plan.
• It keeps you open to opportunities. Market timing—trying to pinpoint precisely when the market will reach its peak or hit the bottom and buying and selling accordingly—is almost impossible, even for professional investors. Dollar-cost averaging helps ensure that you'll be at the door when opportunity knocks. Recent events offer an example as to why a steady investment strategy is so important. If you stopped investing in April 2024—when uncertainty about inflation drove markets downward—you may have regretted your decision in the months that followed as the market surged to record highs.
• Market timers risk missing the rebound. Selling in a panic amid a market decline typically means locking in short-term losses and getting off track from your longer-term plan. Staying the course and rebalancing to keep your targeted allocation consistent is generally a wiser strategy. The biggest gains often come in the early stages of a recovery, and missing even just the first month of gains can have a big effect on future performance.
• It can prevent you from chasing "hot stocks." Far too often, investors focus on the current hot stocks or investment fads and take on more risk in their investment portfolio than necessary to achieve their financial goals. The result is that they frequently become overconfident when markets are rising and then panic when markets are falling. If you have an investing plan and stick to it through dollar-cost averaging, you may be more likely to resist temptation.

As with any investing strategy, however, dollar-cost averaging comes with risks. It doesn't assure a profit or guarantee protection against losses in a declining market. Also, you might miss out on gains you could have had if you'd invested a larger amount right away in a stock or fund that ends up having a big rally. Over long periods of time, dollar-cost averaging tends to produce lower returns compared with lump-sum investing.

Dollar-cost averaging may also help prevent your emotions from undermining your portfolio. When you invest a large sum of money in a single trade, for example, you're more likely to feel regret if that trade turns out to be poorly timed. Behavioral economists note that most people are inherently loss-averse—they tend to react more strongly to losses (or the prospect of them) than gains. But with dollar-cost averaging, you're investing smaller sums of money over time, making it easier to stomach a poorly timed investment.

There's also anchoring bias, in which an investor may refuse to sell an investment bought at a historical high because they think it's still "worth" that value. By dollar-cost averaging into a position, an investor may be less likely to cling to a single price anchor, making it easier to buy and sell according to a predetermined plan. 

It's important for every investor to determine the right strategy based on their situation and needs. While there are risks to consider, dollar-cost averaging can potentially help you take advantage of market opportunities and establish disciplined investing habits.