How Dollar Cost Averaging (DCA) can help during market volatility

Whether markets are reaching new highs or experiencing sharp declines, investors often face a tough decision—should you jump in now, wait for conditions to improve, or hold off for a potential pullback? The fear of "buying at the wrong time" is real, but sitting on the sidelines can mean missing out on long-term growth. Instead of trying to time the market, investors can consider dollar-cost averaging (DCA) as a measured, consistent approach.

What is dollar-cost averaging (DCA)?

Dollar-cost averaging (DCA) is an investment strategy where you divide your total investment amount into smaller, regular contributions over time. Rather than investing a lump sum all at once, you invest the same fixed amount on a regular schedule, regardless of market fluctuations.

By consistently investing, DCA smooths out the impact of market volatility. This approach allows you to buy whole shares, purchasing more when prices are low and fewer when prices are high, resulting in a balanced average cost.

How does DCA work?

To understand how DCA works, consider this simple example:

Imagine you have USD 12,000 to invest in a stock or an exchange-traded fund (ETF).

Instead of investing the entire amount immediately, you decide to invest USD 1,000 each month for 12 months.

Since you can only buy whole shares, any leftover cash is carried over to the next month. Here’s how it might play out:

Summary:

• Total invested = USD 12,000
• Total shares purchased = 125 shares (all whole shares)
• Cash remaining = USD 43 (carried over)
• Average cost per share = USD 96.00

If you had invested the full USD 12,000 at the start of the year when the share price was USD 100, you would have purchased 120 shares. But by using DCA, you bought more shares during market dips, ending up with 125 shares at a lower average cost per share of USD 96.00.

Why should investors use DCA?

DCA offers a systematic approach to investing across various market conditions. Here’s why it works well:

• Reduces emotional decision-making. It’s difficult to predict market tops or bottoms. DCA eliminates the pressure to "get the timing right." By following a set schedule, you avoid the emotional trap of chasing highs or selling lows.
• Lowers the risk of poor timing. Investing in regular intervals minimises the risk of putting a large amount into the market at an unfavourable moment, whether markets are peaking or declining.
• Takes advantage of market dips. When prices fall, your regular investment amount buys more shares, lowering your average cost per share.
• Builds discipline and consistency. Investing regularly turns investing into a habit, helping you stay on track with your long-term financial goals.

When should you use DCA?

DCA works well under various market conditions, making it particularly valuable in the following scenarios:

• When markets are at all-time highs. If you're concerned about buying at the peak, DCA allows you to gradually invest rather than going all in at once.
• When markets are falling or volatile. DCA enables you to take advantage of lower prices, potentially enhancing returns when markets rebound.
• When you have a lump sum to invest. Splitting your lump sum into smaller, consistent investments can make you feel more comfortable during uncertain market conditions.

DCA is versatile and can be effectively applied to both stocks and ETFs, fitting seamlessly into diverse investment portfolios.

Pros and cons of DCA

Like any investment strategy, DCA has strengths and limitations:

Benefits of DCA

• Lowers the risk of poor timing by spreading investments over time.
• Reduces stress by removing the need to predict short-term market fluctuations.
• Makes investing easier, especially during uncertain or volatile market conditions.
• Can be automated through investment apps and platforms, creating a "set-it-and-forget-it" approach.

Drawbacks of DCA

• If markets rise consistently, investing a lump sum upfront may generate higher returns.
• Requires patience, as your investments are only gradually entering the market.
• If markets trend steadily upward, lump-sum investing typically outperforms DCA.

How DCA compares to lump sum investing

A common debate among investors is whether to invest a lump sum all at once or to stagger investments using DCA. Research shows lump-sum investing often outperforms DCA in markets trending steadily higher. However, DCA excels at managing risk and investor emotions. If market volatility or timing concerns make you anxious, DCA allows you to steadily participate in market growth while minimising exposure to significant downturns.

Practical tips to start using DCA

• Set a schedule. Decide how frequently to invest (e.g., monthly or bi-weekly), and commit to your plan.
• Choose an investment vehicle. ETFs, index funds, and individual stocks work well with DCA. ETFs provide additional diversification.
• Automate your contributions. Brokerage platforms often allow recurring investments, ensuring consistency.
• Stick with the plan. Maintaining consistent investments—even during downturns—maximises DCA’s effectiveness.