Dollar Cost Averaging (DCA) Explained with Examples for Canadians

Dollar Cost Averaging refers to an investment tactic where a given amount is allocated over a period of time consistently, regardless of the price of the security.

Dollar cost averaging aims to lower the cost of acquisition of a security by making steady purchases on a periodic basis.

This strategy aids in eliminating guesswork and promotes responsible long-term investing decisions, thereby minimizing rash, irrational decisions.

The underlying premise behind dollar cost averaging is to avoid the temptation to catch the absolute bottom or refrain from investing at the highs in a given market.

Investor psychology swings between greed and fear as they experience market volatility, but by using rules-based systematic asset allocation decisions, they can step aside from such emotional tugs and make rational decisions.

Example of Dollar Cost Averaging

Investors can benefit from dollar cost averaging as it is difficult to catch the lowest point on a price chart, but by strategically deploying capital in a stretch of time, they can increase the odds of ensuring a favourable entry into the investment.

Here is an example of investing in Lithium Americas (LAC) for an investor that allocates 7.2% of their capital consistently every week vs a 100% lump sum investment on a given date.

For simplicity purposes, let’s assume she starts investing from January 3rd and invests at the closing price on Monday at the beginning of each week.

The lump-sum portfolio allocated $10,000 on January 3rd at an average price of $39.23 while the DCA portfolio acquired its LAC position over the course of the next 14 weeks buying $714 ($10,000/14 weeks) worth of stock every Monday.

During the end of the period, the DCA portfolio has accumulated 4.6% of incremental performance.

Date LAC Price ($) Lump-sum Portfolio ($) DCA Portfolio Value ($)
Jan 3 39.23 $10,000 $714
Jan 10 33.91 $8,647 $1,331
Jan 17 37.78 $9,633 $2,197
Jan 24 32.29 $8,230 $2,592
Jan 31 33.29 $8,485 $3,387
Feb 7 34.10 $8,692 $4,184
Feb 14 35.05 $8,934 $5,015
Feb 22 33.71 $8,592 $5,337
Feb 28 36.20 $9,227 $6,660
Mar 7 30.58 $7,795 $6,341
Mar 14 31.10 $7,927 $7,163
Mar 21 38.10 $9,711 $9,489
Mar 28 41.25 $10,514 $10,998

Benefits of Dollar Cost Averaging

1. Rules-Based Investing

Investors can avoid the emotional pitfalls of catching the lows on a stock chart by buying dips blindly and prevent sizing inappropriately into a position by buying too much stock at once.

2. Creates a Saving Habit

When an investor tops up the portfolio at a given interval for a predefined amount they are less likely to spend this money as it’s earmarked for investment purposes and not for discretionary spending.

3. Reduces Cost of Acquisition

By following a DCA approach, investors are more likely to buy securities at a cheaper price rather than lump-sum investing as prices often move randomly in the short run, so the investor benefits from short-term price volatility to pick up shares at a cheaper cost, thereby reducing the cost of acquisition.

Stock trader reviewing monthly statements

Drawbacks of Dollar Cost Averaging

1. Logistics of Execution

The investor has to keep a schedule for purchases to be made of different companies and allocate investing capital on a regular basis based on that schedule.

Unless investors are disciplined and fairly active in the marketplace, they can fall out of a routine and may miss out on the targets set to acquire the desired number of shares.

2. Costs of Execution

As the investor buys smaller quantities on a regular basis, they will incur higher transaction costs such as fees, commission and slippage on these incremental purchases, which would have been avoided in the case of a lump sum investing approach.

3. Net Losing Strategy

In a runaway bull market, dollar cost averaging will be a losing strategy when compared to lump sum investments made initially.

Did You Know?

Paul Tudor Jones had a sign above his monitor that stated: “Losers Average Losers” reminding him to press winning trades and cut losers. This goes against the wisdom of dollar cost averaging and tweaks the approach which suits more active market participants.

Dollar Cost Averaging vs Lump Sum Investing

Most investors will benefit from dollar cost averaging in the short run with market volatility.

However, if we take a step back, markets have trended up over time historically.

In periods of market turbulence, it is important for investors to keep an eye on long-term investing goals and objectives and the least they should do is hold on to existing investments, if not add to those holdings.

It’s important to have high conviction in the portfolio holdings that are meant to perform over a long period of time and shouldn’t be composed of meme stocks that might be flavour du jour.

Dollar Cost Averaging for Crypto

Digital assets have gained widespread adoption across the spectrum of the investor community.

While there is froth in these markets with aggressive speculation, there might be a case for lump sum investing depending on your knowledge base of the market and fundamentals of certain crypto assets so that you can have maximum exposure to upward price appreciation.

However, the average investor, without any significant advantage should be aware of the risks entailed in these products and may be better suited to get exposure to the asset class on a steady basis using dollar cost averaging in order to smoothen out the cost of acquisition.

Frequently Asked Questions

  • Is dollar cost averaging a good idea?
  • What is the best way to dollar cost average?
  • What does DCA mean in Crypto?
Sid Mohapatra

Sid Mohapatra is an energy trader based out of Toronto working in power and natural gas trading. Prior to working in commodities, Sid worked at a top Canadian bank’s fixed income and derivatives business. He possesses strong fundamentals in asset allocation, global macro thematic investing and physical commodities.

As a graduate of McMaster University, Sid specialized in Finance and has taught numerous sessions on Investing, Financial Securities and Trading courses. He led and managed the Horizon’s Trading Center at McMaster University.

Sid’s unique experience brings a breadth of institutional knowledge to the retail investing universe. He covers equity derivatives, structured credit instruments and tax harvesting techniques to help Canadians make better financial decisions in the ever-changing landscape of financial markets and investing.