Dollar Cost Averaging: What is it good for?

Even the phrase “dol­lar cost aver­ag­ing” should put most peo­ple to sleep. Yet, here it is.

Dollar cost aver­ag­ing is an invest­ing “strat­e­gy” that basi­cal­ly says, if you invest the same amount reg­u­lar­ly over time, some­times you buy high and oth­er times low­er. Because you’re invest­ing the same amount of mon­ey each time, when prices are low­er you buy more shares. The way aver­ages work, that means your aver­age pur­chase price is weighed down (which is the right direc­tion) because you buy more shares at the low­er prices than you do at the high­er prices.

That’s a mouth­ful (or para­graph-ful as it is).

I came across an arti­cle on Money Badger (a site you should fol­low, as it has good edu­ca­tion­al mate­ri­als) about dol­lar cost aver­ag­ing with a video explain­er that’s use­ful.

However…

There’s always a ‘how­ev­er’, isn’t there? (It’s because I ask good ques­tions.)

However, I dis­agree with the exam­ple they use. Or rather, I don’t think there exam­ple is the most rel­e­vant.

They start:

Let’s say you have $12,000 and want to invest

 

And go on to tell you to invest $1,000 per month instead of invest­ing all at once in order to cap­ture the ben­e­fit of dol­lar cost aver­ag­ing.

If you were to invest in a div­i­dend pay­ing stock, you’re miss­ing out on a cou­ple of per­cent­age points of return by wait­ing (because you’re not get­ting all the div­i­dends on the unin­vest­ed amount). And, you lose the pow­er of a year of rein­vest­ments and div­i­dend growth (so, your pay­check growth over the course of the year could be about 10% if you invest­ed all at once), if that’s what you choose (and you prob­a­bly should). So, I’m not con­vinced that if you have a lump sum to invest, the best thing to do is spread that invest­ment out over a year. Not to men­tion that many peo­ple would prob­a­bly spend that mon­ey over time if it’s acces­si­ble in a sim­ple sav­ings account wait­ing to be invest­ed.

Creating healthy wealth-building habits

Where dol­lar cost aver­ag­ing is real­ly help­ful is when try­ing to cre­ate an invest­ing habit.

Habit for­ma­tion is an inter­est­ing top­ic as it relates to invest­ing. I talk about it in my book because it’s impor­tant to cre­ate a suc­cess­ful habit for­ma­tion loop in order to devel­op a dis­ci­pline around invest­ing. And, you’re not going to cre­ate a new habit if the habit is not reward­ed (and it’s not reward­ed if each time you invest you feel like you’re los­ing).

In any case, the ideas of mea­sur­ing pay­check and raise are the pos­i­tive rein­force­ment you need to devel­op a good habit.

Dollar cost aver­ag­ing comes in as anoth­er way to rein­force the habit. If you set­up an auto­mat­ic month­ly invest­ment, dol­lar cost aver­ag­ing helps you under­stand why you don’t care about the exact pur­chase price because over time you ben­e­fit by a low­er aver­age cost of pur­chase.

Said dif­fer­ent­ly, you might face two choic­es — buy $50/month auto­mat­i­cal­ly, or put aside $50/month and buy when you think the price is “good”. Putting aside that you’d nev­er real­ly know what that good price is… and the fact that a small price change over a $50 invest­ment real­ly isn’t much… if you buy reg­u­lar­ly and auto­mat­i­cal­ly, you’ll ben­e­fit emo­tion­al­ly with few­er deci­sions to make, and you’ll ben­e­fit finan­cial­ly with dol­lar cost aver­ag­ing low­er­ing your aver­age cost over time.

Building healthy finan­cial habits is hard, just like los­ing weight or any oth­er long-term habit that’s try­ing to change a con­di­tioned behav­ior. Every lit­tle bit helps and that’s why if you can get your head around dol­lar cost aver­ag­ing, it’s worth watch­ing the video on Money Badger.

And, if you’ve read this far and want anoth­er well writ­ten arti­cle, have a look at this arti­cle about Dollar Cost Averaging on Modest Money.

If you’re look­ing to get start­ed devel­op­ing a per­son­al finan­cial well­ness plan, have a look at my free email course Money Making Money.

Enjoy!