Dollar cost averaging
From Wikipedia, the free encyclopedia
Dollar cost averaging is a timing strategy of investing equal dollar amounts regularly and periodically over specific time periods (such as $100 monthly) in a particular investment or portfolio.
- By doing so, more shares are purchased when prices are low and fewer shares are purchased when prices are high.
- The point of this is to lower the total average cost per share of the investment, giving the investor a lower overall cost for the shares purchased over time.
In dollar cost averaging, the investor decides on three parameters:
- the fixed amount of money invested each time, and
- investment frequency, and
- the time horizon over which all of the investments are made.
With a shorter time horizon, the strategy behaves more like lump sum investing.
One study has found that the best time horizons when investing in the stock market in terms of balancing return and risk have been 6 or 12 months.
Criticism of DCA Risk Reduction Theory
Pro: While some financial advisors such as Suze Orman claim that DCA reduces exposure to certain forms of Financial risk associated with making a single large purchase.
Con: Others such as Timothy Middleton claim DCA is nothing more than a marketing gimmick and not a sound investment strategy.
Pro: Others supporting the strategy suggest the aim of DCA is to invest a set amount; the same amount you would have had you invested a lump sum.
Con: Middleton claims that DCA is a way to gradually ease worried investors into a market, investing more over time than they might otherwise be willing to do all at once.
Studies of real market performance, models, and theoretical analysis of the strategy have shown that:
- DCA is associated with lower overall returns, and,
- DCA does not even meaningfully reduce risk when compared to other strategies, even including a completely random investment strategy.
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