Does Dollar Cost Averaging Make Sense For Investors? DCA’S Benefits and Drawbacks Explained
This paper was originally published by Gerstein Fisher in 2011 and updated as of November 2018.
Dollar-Cost Averaging (DCA) is a strategy recommended by many professional money managers as a means of gradually allocating an investor’s portfolio into risky assets such as equities to avoid the perceived risk of investing at the “wrong” time. But do DCA strategies perform better than simple lump-sum investing?
Given the long-term bull market and high equity valuations, a growing number of investors have become wary of putting large blocks of cash to work in the market all at once. Instead, they invest smaller amounts of cash at regular intervals over an extended period of time. This process is called dollar-cost averaging (DCA), a strategy often recommended by investment advisors for risk-averse clients. But does this strategy have any investment merit or is it done primarily to allay the fears of investors? This paper compares the historical performance of DCA with a lump-sum investing strategy where the portfolio allocation into stocks is made at a single point in time.
Dollar-cost averaging is a strategy with which investors gradually put money to work in the market by investing a set amount at a certain frequency (typically monthly). The idea behind DCA is to buy fewer shares when prices are high and more when prices are low. Malkiel (1) stated this principle in his seminal book, A Random Walk Down Wall Street:
Periodic investments of equal dollar amounts in common stocks can substantially reduce (but not avoid) the risks of equity investment by insuring that the entire portfolio of stocks will not be purchased at temporarily inflated prices. The investor who makes equal dollar investments will buy fewer shares when prices are high and more shares when prices are low.