How to Do Dollar Cost Averaging and Why You Should Buy Stocks this Way

If you are saving up money and investing each time you have enough cash, you are doing what is called dollar cost averaging automatically.  In Dollar Cost Averaging (DCA), one invests a fixed amount of money on a regular basis.  For example, an investor may put $1000 in a mutual fund every month regardless of market conditions or other factors.  By fixing the amount, the effect is to buy more shares when the price is relatively low, and less shares when the price is relatively high; therefore, even if the market stays essentially flat, just moving up and down between a couple of limits, because more shares are bought at the lower prices, the cost basis will be below the average of the price range, so a profit will be made.

This is a very automated, easy, no-decision way of investing that is a good approach.  It can also be improved upon, however.

Looking at the chart for any stock, one sees that the price tends to increase for periods, then decrease for periods.  For a stock that is growing (the kind recommended here), the lows will always be higher than the previous lows, and the highs higher than the previous highs – this is called an “uptrend”.  Because the stock does not move randomly, as it falls in price it becomes more and more likely that it will stop falling and move upwards again (again, we’re talking about stocks that over the long-term are growing).  The modification to the dollar cost averaging strategy is then to wait for periods where the stock has fallen in price before making investments.  In doing so, a better price will be gained than that gained through blind averaging.

Choosing when to buy in this method is somewhat arbitrary.  One could buy when the price falls for three days in a row, or when the price drops by 10% or so. Obviously a method should be chosen such that the stock can be bought regularly.  Waiting for the price to drop by 20%, say, before making a purchase, may result in few shares actually being purchased while the stock climbs to the sky, leaving you behind.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

2 thoughts on “How to Do Dollar Cost Averaging and Why You Should Buy Stocks this Way

  1. Interesting idea. I guess the idea behind DCA is to take the emotion out of investing as that is what sinks so many investors. I buy shares of my stocks monthly, but I do tend to spend a little more if the stock price is off it’s highs.

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