Investing 101: Using Dollar Cost Averaging as an Investment Tool

Key Takeaways

• Dollar cost averaging is a way to invest in a disciplined manner.
• By investing over a period of time, dollar cost averaging spreads the price points at which the investment is made and as such reduces the risk from investing right before a drawdown or during a volatile period.

Deciding when to invest

A key problem that many investors face when thinking about income and savings is deciding when to invest and put money to work.

It might seem to make sense to wait until prices are 'low' before investing - however, financial markets are unpredictable. It is challenging to guess when and how far asset prices will fall. A 'low' price today could look 'high' a few months later. Equally, a 'high' price today could look 'low' later on.

Attempting to time the market to achieve a low price is usually unsuccessful. It often means waiting uninvested for a prolonged period, missing out on returns while hoping for a price dip that may or may not happen.

What is Dollar Cost Averaging?

Dollar cost averaging is a way to get invested that does not rely on anticipating market prices.

Instead of investing a sum of money all at once, an investor using dollar cost averaging invests a series of smaller amounts over a fixed time period (for a lump sum) or on a regular basis (for investing income), regardless of whether prices are rising or falling.

By splitting savings into smaller chunks and spreading investments over time, investors may reduce their risk of buying assets at a high price and can take advantage of downward price movements.

Applying Dollar Cost Averaging

To see how this works, the table below shows a hypothetical situation where an investor uses collar cost averaging to invest into a financial asset over the span of a year.

Hypothetical purchase record of a dollar cost average strategy investing $100 per month

Source: Citi Private Bank Global Investment Lab. This hypothetical scenario was created for illustrative purposes only and does not reflect any actual client account/data. Actual portfolio returns may differ significantly due to the products within the portfolio, reinvestments, distributions, fees, commissions and/or other factors.

The investor buys $100 of the asset each month over a year. In the example, the price is the same at the beginning and end of the year, but in between experiences the upward and downward movements that are typical in markets.

Using dollar cost averaging to invest saved $0.40 per unit on average and resulted in five more shares being bought than would have been by investing all at once at the start of the year. The average price paid of $9.60 was lower than the price in 7 of the 12 months.

The best case scenario for the investor would have been to catch the market low in August of $7 per unit and invest all $1200 at once to purchase 171 shares. The worst case would have been to invest all at once in June or November, when $1200 would have only bought 100 units at $12 per unit.

Dollar Cost Averaging in a falling market

The chart below shows the S&P 500 index in 2022. As the index fell, an investor using dollar cost averaging to invest monthly would have steadily reduced the price they invested at. While they would not have achieved the lowest possible price, they would have achieved a lower average price than they would have by investing everything in a lump sum at the start of the year.

Source: Citi Private Bank Global Investment Lab using Bloomberg. Data from 3 Jan 2022 to 3 Jan 2023. DCA buy price is the result of investing 1/12 of the total amount on the first of each month. Lump sum buy price is the price that would have been achieved by investing all the amount at 3 Jan 2022.

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Dollar Cost Averaging in a rising market

In contrast, the S&P 500 index rose overall during 2023. The chart below shows that an investor using monthly dollar cost averaging during 2023 would have purchased at a higher average price than an investor who made a lump sum investment at the start of the year, but would have paid a lower average price than had they waited until the end of the year to invest a lump sum in the hope of lower prices.​

Source: CPB Global Investment Lab using Bloomberg. Data from 3 Jan 2023 to 2 Jan 2024. DCA buy price is the result of investing 1/12 of the total amount on the first of each month. Lump sum buy price is the price that would have been achieved by investing the entire amount on 3 Jan 2023.

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Advantages of Dollar Cost Averaging

1. Potential to invest at lower prices: By not investing all at once, investors have the potential to benefit from later price falls.
2. Habit forming: Committing to fixed periodic contributions instils investing discipline.
3. Psychological: Following the 'rules' of dollar cost averaging can help investors to overcome emotion-driven temptations to react when prices rise or fall sharply.

Drawbacks of Dollar Cost Averaging

1. Underperformance in rising markets: In bull markets, dollar cost averaging can underperform a lump-sum strategy because it keeps some cash temporarily uninvested.
2. No guarantee against loss: Returns can still be negative under dollar cost averaging.
3. Additional dealing costs: A dollar cost averaging strategy may incur more costs than a lump sum strategy because it involves more purchase transactions.

Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.