What to know about dollar-cost averaging, an investing strategy to consider during market volatility (2024)

FAQs

What to know about dollar-cost averaging, an investing strategy to consider during market volatility? ›

The dollar-cost averaging method reduces investment risk, but it is less likely to result in outsized returns. The advantages of dollar-cost averaging include reducing emotional reactions and minimizing the impact of bad market timing

While these shifts can increase anxiety, we know a few things for sure. No one can predict what the market will do and when. History and time have shown that volatility often has an upside, especially when you use the dollar-cost averaging approach.

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 costs.

Investors who use a dollar-cost averaging strategy will generally lower their cost basis in an investment over time. The lower cost basis will lead to less of a loss on investments that decline in price and generate greater gains on investments that increase in price.

Lump-sum investing is usually the better choice

There has been plenty of research done on this subject, so we have an answer on which investment strategy is better. Lump-sum investing outperforms dollar-cost averaging about two-thirds (68%) of the time, according to Vanguard.

Volatility refers to how quickly markets move, and it is a metric that is closely watched by traders. More volatile stocks imply a greater degree of risk and potential losses. Standard deviation is the most common way to measure market volatility, and traders can use Bollinger Bands to analyze standard deviation.

The advantage of dollar-cost averaging: by investing in smaller set amounts over time, you'll buy both when prices are low and high. This smoothes out your average purchase price. Dollar-cost averaging can be especially powerful in recessions and bear markets.

Consistency trumps timing

It sounds technical, but dollar cost averaging is quite simple: you invest a consistent amount, week after week, month after month (think payroll contributions going into your 401(k) account) regardless of whether the markets are up, down or sideways.

Dollar-cost averaging makes a volatile market work to your benefit. By adding money regularly, you're going to buy at times when the market is lower, therefore lowering your average purchase price and actually acquiring more shares.

What are the flaws of dollar-cost averaging? ›

The advantages of dollar-cost averaging include reducing emotional reactions and minimizing the impact of bad market timing. A disadvantage of dollar-cost averaging includes missing out on higher returns over the long term.

When you put all your money in at once, you're more likely to see results quickly. This can be a helpful motivator for a beginning investor. You will often see higher returns with lump sum investing compared to dollar-cost averaging.

Dollar-cost averaging can help risk-averse investors avoid "buyer's remorse" if the market drops sharply since they wouldn't have just invested a big lump sum. Setting up a "mechanical" investment program based on regular savings can help build good financial habits.

From August 2022 through March 2023, Charles Schwab lost deposits due to client cash sorting at a pace of $5.6 billion per month as yields on savings accounts or other safe short-term assets like certificates of deposits rose. These deposit outflow pressures slowed significantly following the regional banking crisis.

Timing the stock market is difficult, but understanding when to trade stocks can help your portfolio. The best time of day to buy stocks is usually in the morning, shortly after the market opens. Mondays and Fridays tend to be good days to trade stocks, while the middle of the week is less volatile.

The data shows lump-sum investing often works in favour of investors. But if you are finding it hard to get back into the market, a DCA strategy can help you take that important first step. It can also provide a smoother investment experience.

If you're dollar-cost averaging into a poor investment, the way you bought in won't save you. The approach works best with broad-based funds such as an S&P 500 index fund, which has performed well over long time periods.

Most investors prefer the monthly dollar cost averaging method. This is a more familiar frequency to those used to a SIPP plan where funds are taken directly from your salary and invested into your investment account.

Daily Volatility is the average difference between the return on a given day and the average return over the time period. To calculate the Daily Volatility you first compute the daily returns over the period in question.