Dollar cost averaging (DCA) is one of the most common and popular investment techniques as you do not need a lump sum of money to start. The goal of DCA is to reduce the impact of volatility on large purchases of financial assets such as equities. DCA is not always the most profitable way to invest a large sum, but it is alleged to minimize downside risk.
What is dollar cost averaging?
DCA allows you to invest a fixed amount of money (e.g. $1,000) on a target asset at fixed intervals (e.g. monthly) over a long period of time. This way, it will help you to reduce the impact of volatility on the overall purchase. The purchases occur regardless of the asset’s price and at regular intervals.
This means that when the share price goes down, you will buy more units of the shares and when the price comes up, you will end up buying fewer units. By doing so, it removes the need for you to time the market in order to make purchases of equities at the best prices.
Month | Share Price | Amount Contributed | Units Bought | Units Owned | Total Value |
1 | $1.00 | $100 | 100 | 100 | $100.00 |
2 | $1.10 | $100 | 90 | 190 | $209.00 |
3 | $0.90 | $100 | 111 | 301 | $270.90 |
4 | $1.00 | $100 | 100 | 401 | $401.00 |
5 | $1.50 | $100 | 66 | 467 | $700.50 |
6 | $1.30 | $100 | 76 | 543 | $705.90 |
7 | $1.35 | $100 | 74 | 617 | $832.95 |
8 | $1.36 | $100 | 73 | 690 | $938.40 |
9 | $1.38 | $100 | 72 | 762 | $1,051.56 |
10 | $1.40 | $100 | 71 | 833 | $1,166.20 |
For example, John works at Acme Pte Ltd and receives a paycheck of $2,500 every month. He then decides to allocate $100 of his pay to an investment product. Every month, $100 of his nett salary will be spent on purchasing $100 worth of units regardless of the fund’s price. The table below shows his contributions to the fund over a period of 10 months. In total, he invested $1,000 but because the price of the fund increased and decreased over several months, John’s average price came to $1.23. This amount was higher than his initial purchase, but it was lower than the fund’s highest prices. Therefore, this method allowed John to take advantage of the fluctuations and made him a profit of $166.20. Since units can only be bought in whole numbers, the numbers in the “Units Bought” are rounded down to the nearest whole number.
Time Period | DCA | Total Contribution | Total Units Bought | Investment Value | Profit/Loss |
10 Months | $1.23 | $1,000 | 833 | $1,166.20 | $166.20 |
In summary, dollar cost averaging refers to the practice of dividing your investment of a fund into smaller equal amount spread out over a period of time at regular intervals. By doing so, it aims to avoid making the mistake of making one lump-sum investment that is poorly timed with regard to asset pricing.
