Dollar-cost averaging
Investing a fixed amount on a fixed schedule removes the timing decision. The tradeoff is cash drag while the money waits.
Dollar Cost Averaging
$300 a month buys 10 shares when the price is $30 and 12 shares when it is $25. Do that for four months and the average market price works out to $29.50, while your average purchase price is $29.07. The gap between those two numbers is the entire mathematical edge of dollar cost averaging, and it is 43 cents.
Worth having. Not worth the sales pitch it usually arrives with.
The arithmetic, and how small it is
A fixed amount of money buys fewer shares when the price is high and more when it is low, so the cheap months carry more weight in your average than the expensive ones. That is why your cost lands below the average price rather than on it.
The cheapest month buys the most shares, the dearest month the fewest. Nobody had to predict anything.
Illustrative. $300 invested on the same day each month at the prices shown.
| Month | Price per share | What $300 buys |
|---|---|---|
| January | $30 | 10.00 shares |
| February | $25 | 12.00 shares |
| March | $35 | 8.57 shares |
| April | $28 | 10.71 shares |
| Total | Average price $29.50 | 41.29 shares, average cost $29.07 |
It is also why the advantage stays small. Buying 41.29 shares at the average price of $29.50 would have cost $1,218. The four monthly purchases paid $1,200 for the same shares. The schedule saved $18, about 1.5%.
Run a falling market through the same four months and the gap widens. At prices of $30, $22, $18 and $26 the average price is $24.00, while $300 a month lands at an average cost of $23.15. That is 85 cents a share below the average, roughly twice the calm example. The mechanism helps most in exactly the months when it feels worst.
The schedule did not beat the calendar. February's $25 price did.
Illustrative. Prices of $30 in January and $25 in February, $1,200 invested in total.
Buying everything in February, at the low price, beat the four-month schedule easily. Buying everything in January lost to it. The order of prices decides the outcome, and you do not know the order in advance. Research on lump sum versus spreading money over twelve months, including Vanguard's study of the question, has found the lump sum ahead in roughly two-thirds of the periods tested, because markets rise more often than they fall.
So what is the schedule for?
Why the schedule wins for most people anyway
It removes a decision you are not equipped to make. Nobody knows whether this month is a good month, and trying to find out has a cost: money that sits in cash waiting for a better entry is money that is not invested while the market climbs.
- Expected return
- Better: Higher about two times in three
- Slightly lower on average
- Worst case
- You buy the day before a crash
- Better: Part of the money buys at the bottom
- What you need to start
- The whole amount
- Better: $25 and a paycheck
- Decisions after setup
- None
- None, if it is automated
VerdictIf you already hold the money, invest it. If you are investing from income, a monthly plan is not a strategy you choose. It is simply what investing from a paycheck looks like, and it is the right way to do it.
Lump sum comparison: Vanguard research on historical US, UK and Australian markets.
A fixed monthly amount is also the only contribution that survives the month the car breaks, because it was decided in a calmer week and the transfer runs without you. A plan that needs a fresh decision every month gets paused in precisely the month it should not be.
The practical case is stronger than the theoretical one. Every broker worth using runs automatic purchases for nothing or close to it. Irregular income fits fine: freelance months are bigger or smaller, so change the amount and keep the date. And a crash becomes a discount instead of a reason to stop.
The method is not for someone already holding $50,000 in cash. Spreading that over twelve months is not caution. It is a deliberate bet that prices will fall.
What $300 a month turns into
- Paid in
- Portfolio value
The gap between the two lines is what compounding adds on top of your own deposits.
Illustrative. $300 invested monthly at 7% a year, compounded monthly, no fees or taxes.
After thirty years you have paid in $108,000 and the account holds about $366,000. The third decade alone adds about $210,000, more than the first two decades combined and four times the whole balance after the first ten years. Nothing about your behavior changed in year twenty. The balance had simply grown large enough for the returns to matter more than the deposits.
That is the honest answer to the most common objection: at the start a monthly plan looks pointless. It looks pointless for years. Then it does not.
Pausing in the middle costs more than it seems to save. Stop for years eleven to fifteen and you deposit $18,000 less, but the ending balance falls from $365,991 to $304,802.
The pause kept $18,000 in your pocket and cost $61,189 at the end, more than three times as much.
Illustrative. $300 a month at 7% a year, compounded monthly, no contributions during the pause.
Setting it up so it survives a bad month
Four things have to be true, and only the first is about investing:
- Pick one broad index fund. One is enough.
- Open a brokerage account, or use your 401(k) or IRA. The differences between the big brokers are smaller than the difference between starting this year and next year.
- Set the date to your payday, so the money never reaches checking as spending money.
- Automate it and forget the login.
The date matters more than the amount. A $50 plan that runs on the 2nd of every month beats a $200 plan that runs when you remember.
What to do when the market falls
Keep buying. That is the whole instruction.
- 01Prices fall 20%The news is bad and your balance is down
- 02The same $300 arrivesThe transfer does not read the news
- 03It buys 25% more shares$300 at $24 buys 12.5 shares instead of 10
- 04Those shares recover with the marketOften the best buys you will ever make
People who stop contributing during a crash make the same timing mistake as people who wait for a dip before starting, just in the other direction.
Illustrative. A $30 share price falling to $24.
You will not feel this at the time. You will feel it in year twenty.
Put the date on payday
Money that never lands in checking never gets spent.
Automate the purchase
A standing order has no opinion about the news.
Ignore the execution price
It is irrelevant to a decision you made once.
Raise the amount once a year
Same date as the annual portfolio check.
Leave the plan alone during a crash
The contribution is the part you control, and the price is the part you do not.
There is no version of this where you need a view on the market. The plan works because it keeps running when you would rather stop, and because the deposits keep arriving in the years when the returns do the heavy lifting.
56 more deep dives are in the Navigator library.
