What is Dollar Cost Averaging ?

Dollar cost averaging (DCA) is a type of investment strategy that can be put to use with any type of currency, be it American, Canadian, Euro, etc. It can be defined as “A technique that is designed to reduce market risk through the systematic purchase of securities at predetermined intervals and set amounts.” In the United States dollar cost averaging is also sometimes referred to as constant dollar plan. In the United Kingdom it is commonly referred to as pound-cost averaging.

Dollar cost averaging (DCA) is a type of investment strategy that can be put to use with any type of currency, be it American, Canadian, Euro, etc. It can be defined as “A technique that is designed to reduce market risk through the systematic purchase of securities at predetermined intervals and set amounts.” In the United States dollar cost averaging is also sometimes referred to as constant dollar plan. In the United Kingdom it is commonly referred to as pound-cost averaging.

There are many investors who have achieved a fair amount of success in investing that use DCA and are not aware that they do. There are others that could benefit from doing so because it would save them time, energy and money. How then does dollar cost averaging work?

Many investors choose to invest their assets in a lump sum. That is not how DCA works. Instead the investor would slowly and meticulously purchase smaller amounts over a longer duration of time. Remember the saying- slow and steady wins the race? That saying would apply to dollar cost averaging. The cost basis is spread out over a number of years as opposed to one or two years. What this does is it insulates assets from fluctuations and changes that take place in the financial markets. It provides a modicum of protection if you would like to look at it that way. It is a conservative means of easing into the markets that can turn out to be very lucrative later on.  

Setting Up a DCA Plan

Setting up a dollar cost averaging plan is easier than you might think. To start with you need to figure out how much money you have available to invest on a monthly basis. Be honest with yourself.  Do a realistic assessment by looking closely at the money you have coming in monthly.  In order for the DCA plan to work and be a success the amount you choose to put into it monthly must be consistent. That is why you need to be as realistic as possible with yourself.

You then need to choose the investment that you wish to go with for the plan. Please note that index funds work very well for this plan. Although they are managed in a passive way they are suitable for this investment arrangement. The investment you choose is for the long-term so bear that in mind. It needs to hold up for a period of five years, 10 years or even longer than that.

The next step in the dollar cost averaging plan is to choose regular intervals for which you will invest your money into the security you have selected. Most people choose weekly, monthly or quarterly intervals but you could choose something else like bi-weekly if you prefer.  Discuss your options with your investment broker. He may suggest an automatic withdrawal plan which will make the process of investing in the dollar cost averaging plan as simple and effortless as can be.