Dollar-cost averaging: How to stop worrying about the market and enjoy automatic investing

Dollar-cost averaging takes the guesswork out of when to invest your money. Instead of trying to time the perfect moment to invest a large sum, you invest smaller amounts regularly – like clockwork, regardless of market conditions. For example, investing $1,000 monthly over a year rather than $12,000 all at once helps protect you from putting all your money in when prices are high.

This approach is useful for all investors, new and experienced. It provides a structured way to keep growing your nest egg while managing risk. When you invest the same amount regularly, you naturally buy more shares when prices are lower and fewer when they’re higher. This can help lower your average cost per share over time.

Think of it like shopping throughout the year instead of doing all your shopping on a single day. Some days you’ll catch sales and get better deals, while other days you’ll pay full price. Over time, you average out the costs rather than risking paying peak prices for everything at once.

Let’s take a closer look at how dollar-cost averaging works and explore how you can begin using it.

In this article

How dollar-cost averaging works

Dollar-cost averaging removes emotion from investing by making it automatic and consistent. Let’s say you decide to invest $1,000 each month in a mutual fund – a basket of hundreds or thousands of stocks and bonds. Some months the share price might be $45, others $40 and still others $50. By investing the same amount monthly, you’ll naturally buy more shares when prices dip and fewer when they rise.

When you use this methodical approach, you avoid common investing mistakes like waiting too long to invest or trying to “time the market” to maximize your profit. Even experienced investors rarely predict market movements accurately. Dollar-cost averaging dodges this challenge entirely by keeping you consistently invested through market ups and downs.

For the dollar-cost averaging strategy to work, you need a few key components that include:

• Regular timing. Set up automatic transfers to your brokerage account or regular contributions to your retirement account on a fixed schedule (daily, weekly or monthly). This helps you stay invested regardless of market conditions.

• Fixed amounts. Decide a dollar amount you can regularly invest without impacting your budget, then invest that same exact amount at the fixed schedule you chose. This helps you avoid emotional decisions about how much to invest.

• Long-term perspective. Commit to this strategy for an extended period, typically a year or longer, to give it time to work through market cycles. This will also help you lower your tax bill on non-retirement investment income since you’d pay favorable long-term capital gains tax rates.

• Diversified investments. Spread your investments across broad market mutual funds or exchange-traded funds (ETFs) rather than individual stocks. These funds typically contain many assets, lowering your risk and helping you avoid tying yourself to a single stock’s performance.

• Automatic execution. Set it and forget it using a robo-advisor, an investment platform that automatically invests the money you transfer to it in a set of funds without requiring manual trades or constant monitoring.

Dollar-cost averaging in practice: Time in the market vs. timing the market

Let’s compare two examples of investing $12,000: dollar-cost averaging over 12 months versus investing it all at once.

Investing with dollar-cost averaging

In this example, you’d end up with 315 shares at an average cost of $41 per share using dollar-cost averaging. Notice how you’d automatically buy more shares in months when prices were lower and fewer when prices were higher.

This automatic adjustment helps reduce the impact of market volatility on your investment. You wouldn’t need to predict market movements or make difficult decisions about when to invest – the strategy would handle that for you.

The consistent monthly investment schedule makes it easier to stick with your investment plan, even during months when the market declines. This psychological relief is an additional perk that adds to the value of this strategy.

Dig deeper: 5 best ways to invest and grow $50,000

Investing all at once

With a lump sum investment in January, you’d acquire 240 shares at $50 each. This approach puts your entire investment to work immediately, which can be beneficial if the market rises throughout the year.

However, this approach also exposes you to more timing risk. Had you invested the lump sum in April instead when shares cost $25, you would have purchased 480 shares – significantly more shares for the same $12,000 investment.

The challenge is that it’s impossible to know in advance when share prices will be at their lowest. The lump sum approach requires lucky timing, that’s why even experienced investors don’t always get it right.

Comparing the results: Dollar-cost averaging vs. lump sum

Let’s look at two year-end scenarios for these two investment approaches:

• The market does well and your share price increases to $60

• The market underperforms and your share price decreases to $30

In both scenarios, dollar-cost averaging provides better outcomes:

• At $60 per share. Dollar-cost averaging delivers a $6,900 gain compared to a $2,400 gain with the lump sum approach. This larger gain comes from systematically buying more shares when prices dipped throughout the year.

• At $30 per share. Dollar-cost averaging helps minimize losses. While both approaches show losses, the dollar-cost averaging strategy delivers a $2,550 loss compared to a steeper $4,800 loss with the lump sum approach. That’s because the lower average cost per share ($41 vs $50) provides better protection from price crashes.

The main disadvantage of dollar-cost averaging is that historically, you’re more likely to earn lower returns compared to investing all at once, since markets tend to rise more often than they fall when considering timeframes of 10 years or longer.

But in reality, it’s impossible to tell if the market will rise or fall in any given period. The benefits of reduced risk and emotional stress often outweigh the potential for higher returns for many investors. This is especially true if you’re in or nearing retirement since risky investments can leave your portfolio with long-lasting damage that takes several years to recover from.

Dig deeper: 7 best low-risk investments for retirees

How to start dollar-cost averaging

You don’t need to be an investment expert or have a lot of money upfront to apply dollar-cost averaging to your investments. In fact, you’re already using this strategy if you regularly contribute to a 401(k) or Roth IRA.

Here’s how to use dollar-cost averaging:

• Choose your investment management option. Decide whether you want to invest through a robo-advisor for complete automation, a traditional brokerage for more control or a financial advisor for personalized guidance.

• Set up automatic transfers from your bank account. Link your checking or savings account to your investment account and choose an amount you can regularly invest – whether it’s $10 or $1,000 every day, week or month.

• Select investments that match your goals. Use a robo-advisor or a financial advisor to have them take care of this step for you. Alternatively, use a traditional brokerage account to choose broad market ETFs or mutual funds that align with your investment timeline and risk tolerance. Broad market ETFs and mutual funds tend to have minimal fees, helping keep more of your money in your pocket. If you use

• Monitor periodically but avoid frequent changes. Check your investments quarterly rather than daily or weekly. Frequent monitoring might tempt you to make emotional decisions. Reviewing your portfolio helps you ensure your investments still align with your original goals. Many robo-advisors handle this automatically for you.

Dig deeper: How to find a trusted financial advisor

Investment management options

Today’s robo-advisors make dollar-cost averaging simpler than ever. These automated platforms typically handle everything from portfolio creation to rebalancing, often for fees of 0.25% or less annually. For example, Charles Schwab Intelligent Portfolios have a 0% annual management fee.

For those who prefer more personalized guidance, traditional financial advisors can help set up and manage a dollar-cost averaging strategy. While their fees typically run around 0.60% to 1.20% annually, they provide customized advice that considers your entire financial picture, including assets outside your investment accounts.

If you like choosing and managing your own investments, you can open a self-directed brokerage account through a brokerage or an investment platform. Many, like Fidelity and SoFi Invest, provide commission-free trading of stocks and ETFs, so you wouldn’t have to worry about regular fees on your trades.

Dig deeper: How to automate investing with robo-advisors

Get matched with a trusted financial advisor in 4 simple steps

Popular robo-advisors for regular automated investing

If you’re looking to automate your dollar-cost averaging strategy, these robo-advisors make it simple to get started. Each offers unique features while keeping fees competitive and minimums accessible for most investors.

Acorns

• Advisory fee: $3 to $12 monthly

• Minimum investment: $0

• Best for: Passive investors who want to invest spare change

Acorns offers a unique approach by rounding up your everyday purchases and investing the spare change automatically. The platform also includes banking features and cashback rewards that you can automatically invest.

Sign up at Acorns

SoFi Robo Investing

• Advisory fee: 0.25% annually

• Minimum investment: $50

• Best for: Investors starting small

SoFi makes automated investing accessible with a $50 minimum investment. Its automated platform provides unique access to assets like real estate.

Sign up at SoFi

Schwab Intelligent Portfolios

• Advisory fee: 0% annually

• Minimum investment: $5,000

• Best for: Fee-conscious investors with larger deposits

While it requires a higher minimum investment, Schwab’s robo-advisor stands out by charging no advisory fees while providing access to its well-established investment expertise and excellent customer service.

Sign up at Charles Schwab

Betterment

• Advisory fee: $4 monthly for balances under $20,000 or 0.25% annually for balances of $20,000+

• Minimum investment: $0

• Best for: New investors who want a comprehensive platform

Betterment shines with its user-friendly approach to automated investing. The platform handles everything from portfolio creation to rebalancing, while offering options for socially responsible investing and retirement planning.

Sign up at Betterment

Wealthfront

• Advisory fee: 0.25% annually

• Minimum investment: $500

• Best for: Tax-conscious investors

As the pioneer of robo-advising since 2008, Wealthfront offers sophisticated features like tax-loss harvesting and access to a wide range of accounts including IRAs and 529 college savings plans.

Sign up at Wealthfront

Vanguard Digital Advisor

• Advisory fee: 0.20% to 0.25%

• Minimum investment: $100

• Best for: Long-term retirement investors

Known for retirement expertise, Vanguard’s robo-advisor combines competitive fees with access to its respected funds and socially responsible investment options.

Sign up at Vanguard

7 common dollar-cost averaging mistakes to avoid

While dollar-cost averaging aims to simplify investing, these seven missteps can reduce its effectiveness at building your long-term wealth.

1. Investing irregularly. Stick to your planned schedule and amount during market ups and downs. Skipping or changing your investment amounts defeats dollar-cost averaging’s purpose.

2. Using money you might need soon. Only invest funds you won’t need for at least one to three years. Keep emergency funds separate in a high-yield savings account.

3. Picking individual stocks. Choose broad market ETFs or mutual funds instead. Individual stocks increase your risk and make it harder to maintain consistent investment amounts.

4. Watching too closely. Avoid checking your investments daily or weekly since this can lead to emotional decisions.

5. Starting with too much. Begin with an amount you can gradually build up over the long term. You get a better dollar-cost averaging effect when you start a portfolio with $1,000 and take 10 months to grow its balance to $10,000 than to start with $5,000.

6. Stopping during market dips. Maintain your regular investments regardless of market conditions. Think of market declines as opportunities to buy more shares at lower prices.

7. Not automating the process. Set up automatic transfers from your bank account. If you use a self-directed brokerage account, you can also set up automatic buy orders to go along with your automatic transfers. This helps you avoid missing contributions with manual investing.

FAQs: Dollar-cost averaging and other investing strategies

Is dollar-cost averaging always the best investment strategy?

While dollar-cost averaging helps reduce the impact of market volatility and the psychological pressure on you, research by Northwestern Mutual found that lump-sum investing outperformed dollar-cost averaging 75% to 90% of the time over 10-year periods across various portfolios. That’s because markets historically trend upward over long periods, so investing a lump sum early on gives you more time to capture potential gains and growth. However, lump sum investing also means risking a larger amount of money all at once.

How is investment income taxed?

The taxes you pay on your investment income vary significantly depending on your account type and holding period. Traditional retirement accounts like 401(k)s let you avoid paying taxes now, but you’ll pay taxes on your contributions and growth when you withdraw in retirement. Roth IRAs let you pay taxes now and get tax-free growth and withdrawals in retirement.

Taxable brokerage and robo-advisor accounts come with annual taxes on dividends and capital gains. You’ll pay lower long-term rates on gains from assets that you hold for more than one year and higher short-term rates on gains from assets you hold under one year. To figure out how much you owe in taxes, use one of the best tax software that can do the math for you like TurboTax or H&R Block.

How frequently should I invest?

One of the most common investment frequencies is monthly investments since they align with regular paychecks. That said, investors who seek more dollar-cost averaging prefer daily or weekly schedules to buy their assets at more price points. The key is to choose a schedule you can stick with – investing $500 monthly without missing a month is better than investing $125 weekly but missing some a few weeks every quarter.

About the writer

Yahia Barakah is a personal finance writer at AOL with over a decade of experience in finance and investing. As a certified educator in personal finance (CEPF), he combines his economics expertise with a passion for financial literacy to simplify complex retirement, banking and credit topics. He loves empowering people to make informed financial decisions that improve their everyday and long-term wellness. Yahia’s expertise has been featured on FinanceBuzz, FX Empire and EarnForex. Based in Florida, he balances his love for finance with freediving, hiking and underwater photography.

Article edited by Kelly Suzan Waggoner