The long-term power of dollar-cost averaging

M1 Team
M1 Team April 29, 2021
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If you’re a fan of movies, music, or TV, you probably subscribe to a streaming service. Every month, you pay a set amount of money to subscribe.

Now imagine your investments as a service. Have you considered subscribing?

This idea is called dollar-cost averaging, and it’s a popular investment strategy among long-term investors.

Much like a subscription, you invest the same amount of money on a regular schedule, no matter the stock price or market conditions. And if your brokerage offers fractional shares, you can purchase fractional shares to keep your portfolio balanced.

Sticking to a regular investing schedule, or “subscription,” can help remove emotional bias and increase convenience. Not only can you worry less about price than you would with other strategies, but it establishes a behavior that quickly becomes an automatic habit. Plus, if you automate your dollar-cost averaging strategy, there’s very little additional action you need to take.

Here’s what smart investors need to know about dollar-cost averaging:

What is dollar-cost averaging?

Dollar-cost averaging, or DCA, is a strategy that involves spreading out your stock or purchases equally over time, regardless of market conditions, price, and volatility.

The idea is that this strategy allows you to buy more shares when the stock price drops and fewer shares when the stock price rises. Over time, this strategy can lower your average cost, build your position in investments you believe in, and leverage the power of compounding to grow your money.

Let’s run through an example.

Say you wanted to invest $10,000 into BLBRY. You’ve done your research. BLBRY fits into your plan and long-term goals, but you’re not sure which way the price will go in the short term.

Instead of guessing, you decide to invest $250 into BLBRY every Tuesday, until you hit your goal of $10,000. You do this no matter the price or market conditions on any given Tuesday, because you know you’re focused on the long run.

But say BLBRY’s part of your M1 portfolio, and you don’t really have a cap in mind when it comes to that position. You can invest that $250 in your Pie on the same schedule, with the same guidelines. That would be considered perpetual dollar-cost averaging.

It’s a great way to take the emotion out of investing and make it easier for you to do.

Does DCA really work?

Like so many investment strategies, it depends. There are a lot of factors that impact the outcome of an investment. But in general, lump-sum investing (the opposite of DCA), is often considered a riskier strategy since it relies on market timing.

Let’s look at DCA in three possible market scenarios: a bull market, a flat market, and a bear market.

1. DCA in a bull market

DCA can be seen as least effective in a bull market since the price of stock rises while you regularly purchase over time. However, this is a short-term point of view. Stocks are volatile and can move down over time. A DCA strategy can help some investors buy the dips without timing the market, building up their portfolio over the long run.

2. DCA in a flat market

In a flat market, your gains and losses remain, on average, the same. Historically, however, the market generally rises over time.

3. DCA in a bear market

In a bear market, a DCA strategy buys the dip. This can let a long-term investor buy more shares. While many short-term investors sell off their shares in fear, a long-term investor building up their position via DCA would continually buy these shares at a low price regardless of market volatility.

What are the benefits of DCA?

Dollar-cost averaging provides 3 key advantages:

  1. It does not rely on timing the market.
  2. It takes the emotion out of investing.
  3. It works well with compounding.

Is DCA the best way to invest?

There’s no “best” way to invest. And while DCA has its advantages, it has disadvantages too:

  1. Buying more frequently can add to trading costs.
  2. An investor may miss out on gains or short-term market movements.
  3. Like all investment strategies, there’s a risk of loss.

Ultimately, you need to choose the investment strategy that’s right for you and your goals. Whether it’s DCA or lump-sum investing, you’re in charge of your portfolio and the shares you buy.

Creating your own DCA strategy

If you do choose to build DCA into your investment strategy, you need to decide on your portfolio mix, your contribution amount, and your brokerage.

We’re serious, your brokerage can make a big difference. This investment strategy is much easier to execute when you have the right tools on your side and the right control over your portfolio.

For example, fractional shares can be very helpful in DCA strategies. Fractional shares let investors buy stock based on their own dollar amount rather than the price of the whole share. This is particularly helpful if you’re trying to maintain a diversified, balanced portfolio.

Regular contributions don’t always spread out evenly, but fractional shares give long-term DCA investors the chance to make regular contributions, follow their DCA plan, and keep their allocations in check.

Automation is another great example of how the right tools can make this strategy easier to execute. Investors can set up regular contributions and spend even less time trying to remember to follow through. We offer automation and fractional shares on M1 and have seen both features used in use cases like this one.

Overall, DCA is a great strategy for different types of investors. It’s not the only one out there, but it might be one to consider.