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| '''Dollar cost averaging''' ('''DCA''') is an [[investment strategy]] for reducing the impact of [[volatility]] on large purchases of financial assets such as [[equities]]. By dividing the total sum to be invested in the market(eg $100,000)into equal amounts put into the market at regular intervals (eg £1000 over 100 weeks), DCA reduces the risk of incurring a substantial loss resulting from investing the entire "lump sum" just before a fall in the market. However, evidence based on real market data suggests that the opportunities for DCA to give better returns are limited, making a lump sum approach optimal, at least if risk of market timing regret are ignored<ref>[https://pressroom.vanguard.com/nonindexed/7.23.2012_Dollar-cost_Averaging.pdf]</ref>
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| In essence, the technique works in markets undergoing temporary declines because it exposes only part of the total sum to the decline. The technique is so-called because of its potential for reducing the average cost of shares bought. As the amount of shares that can be bought for a fixed amount of money varies inversely with their price, DCA effectively leads to more shares being purchased when their price is low and fewer when they are expensive. As a result, DCA can lower the total average ''cost per share'' of the investment, giving the investor a lower overall cost for the shares purchased over time.<ref>''Chartered Retirement Planning Counselor Professional Designation Program'', College for Financial Planners, Volume 9, page 64</ref>
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| Dollar cost averaging is also called the '''[[constant dollar plan]]''' (in the [[United States|US]]), '''pound-cost averaging''' (in the [[United Kingdom|UK]]), and, irrespective of currency, as '''unit cost averaging''' or the '''cost average effect'''.<ref>{{cite web|url=http://de.wikipedia.org/wiki/Durchschnittskosteneffekt|title=Durchschnittskosteneffekt|accessdate=2009-01-12}}</ref>
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| ==Parameters==
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| In dollar cost averaging, the investor decides on two parameters: the fixed amount of money invested each time, and the time horizon over which all of the investments are made. With a shorter time horizon, the strategy behaves more like [[lump sum]] investing. One study has found that the best time horizons when investing in the stock market in terms of balancing return and risk have been 6 or 12 months.<ref>{{cite web|url=http://www.efficientfrontier.com/ef/997/dca.htm|title=Do Not Dollar-Cost-Average for More than Twelve Months|last=Jones|first=Bill|accessdate=2009-01-05}}</ref>
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| One key component to maximizing profits is to include the strategy of buying during a downtrending market, using a scaled formula to buy more as the price falls. Then, as the trend shifts to a higher priced market, use a scaled plan to sell. Using this strategy, one can profit from the relationship between the value of a currency and a commodity or stock{{citation needed|date=January 2014}}.
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| == Return ==
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| Assuming that the same amount of money is invested each time, the return from dollar cost averaging on the total money invested is<ref>{{cite web|url=http://tsp.peacefulgains.com/Derivation-of-the-dollar-cost-averaging-return-formula/|title=Derivation of the dollar cost averaging return formula|accessdate=2009-01-05}} {{Dead link|date=October 2010|bot=H3llBot}}</ref>
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| <math>r = \frac{p_F}{\tilde{p}_P} - 1,</math>
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| where <math>p_F</math> is the final price of the investment and <math>\tilde{p}_P</math> is the [[harmonic mean]] of the purchase prices. If the time between purchases is small compared to the investment period, then <math>\tilde{p}_P</math> can be estimated by the harmonic mean of all the prices within the purchase period. | |
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| ==Criticism==
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| The pros and cons of DCA have long been a subject for debate among both commercial and academic specialists in investment strategies.<ref>[http://www.cass.city.ac.uk/__data/assets/pdf_file/0009/56898/3B_Hayley.pdf Explaining the riddle of dollar cost averaging Hayley, S Cass Business School report 2010]</ref> While some financial advisors such as [[Suze Orman]] <ref>http://www.suzeorman.com/dt/calc_dollarcostaverage1.cfm</ref> claim that DCA reduces exposure to certain forms of [[financial risk]] associated with making a single large purchase, others such as Timothy Middleton claim DCA is nothing more than a marketing gimmick and not a sound investment strategy.<ref>{{cite web|url=http://web.archive.org/web/20050910142530/http://moneycentral.msn.com/content/P104966.asp|title=The costly myth of dollar-cost averaging|last=Middleton|first=Timothy|date=2005-01-04|accessdate=2009-01-05}}</ref> The financial cost and benefit of DCA have also been examined in many studies using real market data.<ref>Knight, J.R. and Mandell, L. Nobody Gains From Dollar Cost Averaging: Analytical, Numerical And Empirical Results. Financial Services Review, Vol. 2, Issue 1 (1992/93 pp. 51-61</ref><ref>Greenhut, J.G. Mathematical Illusion: Why Dollar-Cost Averaging Does Not Work. Journal of Financial Planning, Vol. 19, Issue 10 (October 2006), pp. 76-83</ref>
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| Recent research has highlighted the [[behavioural economics|behavioural economic]] aspects of DCA, which allows investors to make a trade-off between the regret cause by not making the most of a rising market and that caused by investing into a falling market, which are known to be asymmetric.<ref>[http://www.acsu.buffalo.edu/~keechung/Lecture%20Notes%20and%20Syllabus%20(MGF633)/Behavioral%20Aspects%20of%20DollarCostAveraging.pdf] University of Buffalo report</ref> Middleton claims that DCA helps investors to enter the market, investing more over time than they might otherwise be willing to do all at once. Others supporting the strategy suggest the aim of DCA is to invest a set amount; the same amount you would have had you invested a lump sum.<ref>{{cite web|url=http://beginnersinvest.about.com/cs/newinvestors/a/041901a.htm|title=Dollar Cost Averaging: A Technique that Drastically Reduces Market Risk|accessdate=2009-03-22}}</ref>
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| ==Confusion==
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| Discussions of the problems with DCA can do a disservice to investors who confuse DCA with continuous, automatic investing. This confusion of terms is perpetuated by some articles ([[AARP]],<ref>{{cite web|url=http://www.aarpfinancial.com/content/YourGoals/savForRet_hdnBenefitAutoInvest.cfm|title=The hidden benefit of an automatic investing program|accessdate=2009-05-02}}</ref> [[Motley Fool]]<ref>{{cite web|url=http://www.fool.com/investing/mutual-funds/2008/12/21/dont-make-a-million-dollar-mistake.aspx|title=Don't Make a Million-Dollar Mistake|accessdate=2009-05-02}}</ref>) and specifically noted by others ([[The Vanguard Group|Vanguard]]<ref>{{cite web|url=https://pressroom.vanguard.com/nonindexed/7.23.2012_Dollar-cost_Averaging.pdf|title=Dollar-cost averaging just means taking risk later|page=4|accessdate=2013-01-28}}</ref>). The argued weakness of DCA arises in the context of having the option to invest a lump sum, but choosing to use DCA instead. If the market is expected to trend upwards over time,<ref>{{cite web|url=http://dailyspeculations.com/scholarly/LongTermStockReturns.html|title=Long Term Returns (a survey of studies)|accessdate=2011-03-13}}</ref> DCA can conversely be expected to face a statistical headwind: the investor is choosing to invest at a future time rather than today, even though future prices are expected to be higher. But most individual investors, especially in the context of retirement investing, never face a choice between lump sum investing and DCA investing with a significant amount of money. The disservice arises when these investors take the criticisms of DCA to mean that timing the market is better than continuously and automatically investing a portion of their income as they earn it. For example, stopping one's retirement investment contributions during a declining market on account of the argued weaknesses of DCA would indicate a misunderstanding of those arguments.
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| The weakness of DCA investing applies when considering the investment of a large lump sum, and DCA would postpone investing most of that sum until later dates. Given that the historical market value of a balanced portfolio has increased over time, starting today tends to be better than waiting until tomorrow. However, for the average retirement investor's situation where only small sums are available at any given time, the historical market trend would support a policy of continuous, automatic investing without regard to market direction.
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| ==References==
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| <references/>
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| *''The Intelligent Investor: revised 1972 edition'' Benjamin Graham, Jason Zweig. Collins, 2003. ISBN 0-06-055566-1
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| * [http://www.investopedia.com/terms/d/dollarcostaveraging.asp Investopedia]
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| {{stock market}}
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| {{DEFAULTSORT:Dollar Cost Averaging}}
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| [[Category:Investment]]
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Emilia Shryock is my title but you can call me anything you like. What I adore doing is to gather badges but I've been using on new issues recently. Puerto Rico is exactly where he and his wife live. For many years I've been working as a payroll clerk.
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