What is dollar-cost averaging?

Dollar-cost averaging means investing a fixed sum of money on a fixed schedule, regardless of price. The same amount goes in each time — a common convention is monthly, because that is how salaries tend to arrive, though nothing about the arithmetic cares either way. Despite the name, the mechanic works in any currency. What it removes is a decision: when to buy.

The mechanic

Because the amount of money is fixed, the number of units bought is not. When the price is low, the same money buys more units; when the price is high, it buys fewer. The purchases lean, automatically, towards the cheaper moments — not through foresight, but through division. Whether the units are individual shares or something pooled like an index fund, the arithmetic is identical.

A worked example

All numbers here are purely hypothetical. Suppose 100 is invested on each of three dates, and the price per unit is 10, then 5, then 10.

• First purchase: 100 buys 10 units.
• Second purchase: 100 buys 20 units.
• Third purchase: 100 buys 10 units.

That is 40 units for 300 — an average cost of 7.50 per unit. The average of the three prices, though, was 8.33. The average cost came in below the average price because more of the units, as a share of the total, landed on the cheap date — 20 of the 40, half the units for a third of the money. That gap is the whole trick, and it is a property of division, not of skill.

What it is for

Chiefly, discipline. A fixed schedule removes the temptation to wait for a better price, and the equal temptation to pile in after a rise. It converts a stream of hard decisions into one standing instruction, which then runs quietly while compounding does whatever it is going to do. It also spreads the purchases across time, so the outcome rests on many entry prices rather than one.

What it is not

It is not a way to beat investing everything at once. Someone holding a lump sum who drip-feeds it in is keeping most of the money out of the market while the schedule runs. Whether that helps or hurts depends entirely on where prices go next, which is precisely the thing nobody knows. If prices mostly rise over the period, the drip-feeder pays more on average; if they fall first, less. No verdict is offered here, because none is available in advance.

The costs

Each scheduled purchase is a transaction, and transactions can carry fees. Twelve small purchases can cost more in charges than one large one, depending on how a platform prices its trades. A flat fee bites hardest on small amounts: a purely hypothetical 5 charged on a 100 purchase is 5% gone before anything else happens.

What this article does not know

Whether averaging in will do better or worse than any alternative depends on a price path that has not happened yet. Nothing here says what to buy, how much, or whether investing suits a given situation at all — those depend on circumstances no article knows. Dollar-cost averaging is a schedule, not a forecast. It ensures nothing except that you will have bought.