Dollar Cost Averaging (DCA) is the practice of buying a specific dollar amount of an investment at set intervals (monthly, annually etc). Proponents say the strategy helps reduce risk because you are buying more shares when prices fall (as your set amount doesn’t change) and fewer shares when prices rise. This can result in the overall cost of the shares purchased being lower than if a set number of shares were purchased at those same intervals.
DCA tends to work in a market that sees fluctuations but doesn’t work as well in the market environment that we have been in since 2009. For instance, using the S&P 500 Index as a reference for price and return of our investment, a lump sum of $10,000 (7.82 shares at a price of $1,278.04 on June 1, 2012) invested on June 1, 2012, has had a return of 84.06% for an ending value of $18,406.07. On the other hand, had we invested $2,000 every June 1 over the past 5 years ($10,000), our account would be worth $13,736.43 for a difference of $4,669.64. In terms of shares, we would own 6.546 shares at an average price of $1527.68 as fewer shares were bought as the price went up.
In this instance, DCA appears to be more of a behavioral crutch than a risk mitigation strategy. We are not advocating for one method over the other, we are simply providing an example of how such a strategy works and how market volatility can impact such a strategy. While there are many different investment implementation methods out there, there’s never a one size fits all scenario as each client has their own set of circumstances. We recommend having an investment plan and sticking to it.
Keep in mind that all performance data mentioned above is for representation purposes only. You cannot invest directly in the S&P 500 Index. All returns data was provided via Bloomberg. The 5-year period data was from May 31, 2012 - May 31, 2017.
Dollar Cost Averaging does not ensure a profit or guarantee against loss.
