Dollar-cost averaging explained: How it works during volatile markets

Key takeaways:

• Dollar-cost averaging is an investment strategy where a fixed amount is invested at regular intervals, spreading entry points over time instead of investing a lump sum all at once.
• DCA can reduce reliance on a single market entry point and may help manage timing-related decision pressure during volatile markets, but it does not guarantee better returns.
• How DCA works depends on the price path: falling or fluctuating prices may result in more units bought, while steadily rising markets may favour lump-sum investing.
• The benefits of DCA include structure, consistency and automation, while drawbacks include slower market exposure and the possibility of lower returns if markets rise during the investment period.
• Practical considerations when using DCA include setting a schedule, choosing suitable investment products, automating contributions and reviewing the plan periodically.

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 waiting can also mean returns depend on a later entry point. Instead of trying to time the market, some investors use DCA to spread entry points over time.

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. However, it does not guarantee a lower average cost or better returns than investing a lump sum.

By consistently investing, DCA can spread the timing of purchases across different market prices. Depending on the broker and product, investors may buy whole or fractional shares, purchasing more when prices are low and fewer when prices are high, resulting in an average purchase price across the investment period.

How does DCA work?

To understand how DCA works, consider this simplified 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.

The following example assumes that only whole shares can be purchased. Any cash left over after each purchase is carried forward to the next month. It also excludes transaction costs, taxes, currency conversion costs, bid-ask spreads and dividends:

Summary:

• Total contributed: USD 12,000
• Total used to buy shares: USD 11,993
• Total shares purchased: 126 shares
• Cash remaining: USD 7
• Average purchase price : USD 11,993 ÷ 126 = USD 95.18, approximately

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, excluding any costs.

In this specific price path, DCA results in more shares and a lower average purchase price because the share price falls below the starting price for much of the period. In a different market path, especially if prices rose steadily, DCA could result in fewer shares or a higher average purchase price than investing the full amount upfront. The example shows how DCA spreads purchases over time, not that it produces a better outcome in every market.

Why some investors use DCA

DCA offers a systematic approach to investing across various market conditions. Common reasons include:

• May reduce timing-related decision pressure. It’s difficult to predict market tops or bottoms. DCA reduces the need to choose a single entry point. By following a set schedule, it may help some investors follow a pre-set contribution schedule.
• Can reduce the risk of investing the full amount immediately before a downturn. 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.
• Buys more units when prices are lower. When prices fall, your regular investment amount buys more shares, lowering your average cost per share, in some market paths, but not all.
• Builds discipline and consistency. Investing regularly turns investing into a habit.

When DCA may be considered

DCA may be useful for investors who want to spread entry points across different market conditions, making it particularly valuable in the following scenarios:

• When markets are at all-time highs. When investors are concerned about investing a lump sum near a market high, DCA allows them to gradually invest rather than going all in at once, although this may underperform lump-sum investing if markets continue rising.
• When markets are falling or volatile. DCA means fixed contributions buy more units when prices are lower, but returns still depend on whether and when markets recover.
• When you have a lump sum to invest. Splitting your lump sum into smaller, consistent investments may feel more manageable for some investors during uncertain market conditions.

DCA is versatile and can be effectively applied to both stocks and ETFs, although suitability depends on the investor’s objectives, time horizon and product choice.

Pros and cons of DCA

Like any investment strategy, DCA has strengths and limitations:

Benefits of DCA

• Reduces reliance on a single entry point by spreading investments over time.
• May reduce timing-related stress for some investors by removing the need to predict short-term market fluctuations.
• Can make contributions more structured, especially during uncertain or volatile market conditions.
• Can be automated through investment apps and platforms, creating a recurring contribution schedule.

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.
• Can leave part of a lump sum uninvested for longer, which may reduce returns if markets rise during the investment period.

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. Some studies have found that lump-sum investing has often outperformed DCA over certain historical periods, particularly when markets rise during the investment period. However, DCA may help manage timing risk and make the investment process feel more manageable for some investors. If market volatility or timing concerns make you anxious, DCA allows you to gain market exposure gradually. It may reduce the risk of investing the full amount immediately before a downturn, but it does not prevent losses if markets fall.

Practical considerations when using DCA

• Set a schedule that matches your cash flow and investment horizon. Decide how frequently to invest (e.g., monthly or bi-weekly), and commit to your plan.
• Select an investment product carefully. DCA can be applied to ETFs, funds or individual stocks, although risk varies significantly by product. Some ETFs provide diversification, depending on what they track.
• Automate your contributions. Automation can support consistency, but investors should still review whether the product remains suitable.
• Review the plan periodically. Maintaining consistent investments—even during downturns—can help keep the approach consistent over time.