For as long as I can remember, I wanted to be wealthy.
I didn’t want to have to worry about money.
So I started to look into how the rich became wealthy.
The most common ways are starting a business and investing in the stock market.
At the age of 18, I didn’t have any desire to start a business, let alone any ideas of what to start.
So I turned my attention to investing.
I started reading a lot of investing books.
In college, I took some classes on investing.
And I started to apply the knowledge I learned.
One of the most important thing I learned was dollar cost averaging.
By using dollar cost averaging, also called DCA, I have been able to grow my wealth to close to seven figures.
And it all started with $25 a month.
In this post, I am going to show you the how it works and how to start dollar cost averaging.
The Complete Guide To Dollar Cost Averaging
Dollar Cost Averaging vs. Lump Sum Investing
When it comes to investing your money, there are primarily two strategies you can use.
- Lump sum investing
- Dollar cost averaging
Both of these come with advantages and disadvantages, which I detail below.
What Is Lump Sum Investing?
Lump sum investing is fairly straightforward.
You have a chunk of money to invest and you invest all of it at once.
So, if you have $10,000 you want to invest in the stock market, you do it on a given day.
The advantage of lump sum investing is that you are invested in the market.
You won’t be tempted to go out and buy things with the money, like a new car or smart phone, instead of investing it.
Another advantage is that over the long term, you will grow your wealth.
This is because the market tends to move higher over time, so any investment you have will grow in value.
The disadvantage of lump sum investing is that you might invest all of your money when the market is at a peak.
If the market drops, you could end up spending some time, possibly years, waiting for the market to recover.
For example, imagine if you had invested the $10,000 right before the markets crashed in 2008.
You would have had to wait until 2011 at the earliest just to get back to your starting amount of $10,000.
To avoid the chance of this, you can elect to implement dollar cost averaging instead.
What Is Dollar Cost Averaging?
Dollar cost averaging is simply taking your money and investing it over a period of time.
Using the example from above, if you had $10,000 to invest, you could use this strategy and invest $1,000 per month for ten months.
Or you could invest $500 a month for 20 months.
The amount you invest each month and duration is up to you.
The advantage of dollar cost averaging is that you are buying regardless if the market is rising or falling.
When the market is rising, you buy fewer shares. When the market is falling, you buy more shares.
When you combine the two, your overall purchase price is lower, increasing you long term gains.
The disadvantage of this strategy is since you aren’t investing all your money at once, you might be tempted to spend it or not invest it, especially when the market is falling.
The question you might have is how does this strategy work exactly? Here is an example.
Dollar Cost Averaging Example
For this dollar cost averaging example, I am going to use real-life data.
I am going to use the Vanguard 500 Index Fund (VFINX) as the investment choice.
I am going to invest $1,000 each month for 10 months on the first business day of each month.
I will use January 2, 2015 as my starting date and invest $1,000 each month through October.
I will then look at the ending value as of June 17, 2016 which is when I calculated the data for this example.
In the chart below, you will see the ending daily value for VFINX as well as how many shares I was able to buy for $1,000.
I rounded the purchases to 4 decimal points as most mutual funds do.
After I make the final investment in October of 2015, I own a total of 53.9244 shares.
Fast forward now to June 17, 2016 and we see that the VFINX closed at $191.94.
By taking the number of shares I own and multiplying that by $191.94, my total investment is worth $10,350.25.
I ended up gaining $350 by dollar cost averaging.
Which Investing Strategy Is Better?
If you are curious, you probably want to know what would have happened if I had just went ahead with lump sum investing instead.
Here is what would have happened.
I would have invested all $10,000 into the VFINX on the first business day in January 2015 and owned 53.9957 shares as a result.
Fast forward to June 17, 2016 and my investment would be worth $10,363.93.
I gained $363 by using the lump sum investing strategy.
This strategy ended up earning me an additional $15 compared to dollar cost averaging.
So is dollar cost averaging worth it?
Should you just use lump sum investing all of the time?
The answer isn’t so simple.
Does Dollar Cost Averaging Work?
Based on the examples from above, you are probably thinking that using dollar cost averaging does not work and isn’t worth the hassle.
After all, you would have made more money by lump sum investing as opposed to dollar cost averaging.
But there are some key reasons as to why you should not completely rule out dollar cost averaging as an investment strategy.
Benefits Of Dollar Cost Averaging
Goal of minimizing risk
When you use dollar cost averaging, you minimize risk by investing over a period of time.
You have no idea when the market is at a peak, so by systematically investing each month for a period of months, you lessen the risk of investing at the wrong time.
Another reason to look into dollar cost averaging is to buy low.
Any decent investment book you read will tell you to buy low.
The problem is that when emotions and money interact, we rarely buy low.
We try to time the market and invest at precisely the right time.
But no one knows when the perfect time is to invest.
We most likely buy high, when everyone is excited and making money hand over fist as seen in the graph below.
You should be investing at the opposite time, when the market is dropping.
You will buy more shares and will have a greater return when the market goes back up.
Finally, dollar cost averaging works, especially over the long term.
When I speak of the long term, I mean over 10 years or greater.
Yes, the lump sum strategy I pointed out works better here, but that is only over a period of roughly a year.
You need to look long term.
Many of the arguments against dollar cost averaging won’t look this far ahead.
They will point out one year or two years later how you would have been better off investing with a lump sum.
So should you use dollar cost averaging all of the time?
Unfortunately, the answer is still not so simple.
Downsides Of Dollar Cost Averaging
So those are the reasons why you should consider dollar cost averaging but what are some downsides of dollar cost averaging?
You could run into commissions and fees depending on how you go about using DCA.
For instance, many brokers charge commissions on stock trades.
If yours does, a lump sum investment would save you money.
Of course, you could change to a no fee broker like M1 Finance.
If you invest in mutual funds, some brokers charge a fee here too.
You would be better served investing directly with the mutual fund company instead.
With some brokers, you need a minimum amount to invest, especially when it comes to exchange traded funds.
You might need $100 or more, which could be more than you have to invest.
An alternative is to invest directly with a mutual fund company. Most allow you to auto invest for $25 a month.
You’re a worrier
If you are easily spooked when it comes to investing, a lump sum strategy might be better for you.
The reason is because you can invest once and be done.
With a dollar cost averaging strategy, you might get scared and skip an investment month here and there.
Doing this will hurt you tremendously, mainly because the most likely outcome is that you will spend the money instead.
You’re stuck on an investment
Another reason to skip dollar cost averaging is if you are in love with a loser.
By this I mean a stock that is dropping each month.
You might get excited that you are buying low and owning more shares each month, but the truth is you are just throwing money away on a stock that is going nowhere.
An example of this would be Enron. You can also read my experience with this when I was investing in Worldcom.
How To Start Dollar Cost Averaging
How do you get started with dollar cost averaging?
You need to decide on a few things.
#1. How much do you want to invest?
#2. How often do you want to invest?
#3. What do you want to invest in?
Once you answer these questions, you can set up your dollar cost averaging plan.
For most people, the easiest way is to start a DCA plan is to invest in your 401k plan at work.
Every time you are paid, a portion of your money is invested into your retirement plan, regardless if the market is up or down.
So if you have the option to invest in a 401k, then make sure you do.
From there, you have two options.
- Invest in stocks/exchange traded funds
- Invest in mutual funds
If you are interested in investing in stocks or exchange traded funds, I suggest you invest with M1 Finance.
You can build your own custom portfolio of just stocks, just exchange traded funds, or a combination of both.
Or you could pick a portfolio their experts built.
They charge zero fees and you can invest $25 a month.
It’s simple and easy. And it is my favorite way to invest for free.
You can click below to learn more and open your account.
If you are interested in investing in mutual funds, don’t invest through a broker.
This is because many charge you a fee to invest when you can invest for free directly with the fund company.
Another reason is because a broker might have a higher investment requirement.
To help the broker keep costs down, they force you to invest at least $100 or $250.
But when you invest directly with a mutual fund company, you can invest every month for $25.
A good option here is T. Rowe Price. They have a large variety of high quality mutual funds to pick from.
How Dollar Cost Averaging Builds Wealth
At the beginning of this post, I told you how I grew my wealth by following a dollar cost averaging strategy.
Here is how I did it.
I started off with an index mutual fund that mimicked the S&P 500 Index.
Every month I invested $25.
And when I received money for my birthday or the holidays, I took a portion of the money and invested it as well.
About a year later, I earned a raise at work.
Instead of just taking the bigger paycheck, I opened up another index mutual fund, this time one that tracked small cap stocks.
Every month I put $25 into this investment.
When I received extra money, I split it between my 2 investments.
A few years later, I was able to increase my monthly investment up to $50 each.
All during this time, I was also investing in my 401k plan.
At the beginning, it was $20 a paycheck.
But it increased every time I earned a raise.
I just kept this process on autopilot, investing every single month, not worrying what the stock market was doing.
In time, my investments grew to where they are today.
This is why I recommend you invest with a dollar cost averaging plan.
Most people allow their emotions to interfere with their decisions.
They get scared and stop investing and never start back up.
Or they intend to invest their tax refund but instead but the new smartphone.
By putting your investing on autopilot, you build wealth over time.
By investing a little amount over time, you guarantee that you will be investing your money and saving for the future.
Many mutual fund companies even let you invest as little as $50 or $100 each month.
In fact, just about every one of us uses dollar cost averaging when investing in our 401(k) plan.
Therefore, I recommend you start there.
Try to invest 10% in your 401k plan.
If that is too much, start with 5%.
No matter how much you start with, put a reminder on your phone to increase this amount 1% next year.
When it comes to investing outside of your 401(k), M1 Finance allows for easy, low cost dollar cost averaging investing, and it’s the broker I recommend.
At the end of the day, dollar cost averaging is a viable option when investing your money.
If you want to learn more about how to become a successful investor, I recommend you read the posts below.