There is a common misconception about Dollar Cost Averaging (DCA). Let’s say you’re paid twice a month, and on each payday you regularly contribute to your retirement accounts. “I’m dollar cost averaging!” you might say. No, you’re not. You are doing something even better! Investing as soon as you have the money and maximizing time in the market with compounding over decades because no one can guess the future. See The Market goes UP and DOWN.
Dollar Cost Averaging implies you are choosing when to invest the money you already have.
Let’s say you saved $2,000 over 3 months in a savings account…
- Option A: The stock market dips for three days straight and you buy! You are timing the market. Only hindsight is 20/20; you’re betting it was actually a good time to buy.
- Option B: You keep the cash in savings because “the market is over-priced”. Again, you’re timing the market.
- Option C: You’ve been studying the market for those 3 months and you are sure which stock is under-valued. Confident in your answer [but having absolutely no idea what will actually happen], you click “Trade”. You are timing the market.
- Option D: You Dollar Cost Average by buying $500 worth of stock a week for the next 4 weeks. Or should it be $250/wk over 8 weeks? Or… It’s the reasonable option, right? Right? Again, you are timing the market. You are smoothing out the volatility, sure, but will have lower or higher returns based purely on happen-chance.
Exploring “Option D: Dollar Cost Averaging” further… Let’s say stock prices plummet starting on week 3 of your averaged stock purchases. You’ll be ecstatic you waited to buy at least some of your shares. What if instead of a recession, stock prices soar week after week after week? You’ll be kicking yourself for not buying all your stocks when prices were low. What if stock prices stay flat? No harm, no foul.
No matter which stock market scenario, you were guessing. Dollar Cost Averaging could have made you money, lost you money, or not mattered at all. All you did was average your volatility; any return potential was pure guessing!
Have some made money actively trading? Yes.
Has anyone consistently beat the overall market, such as the S&P 500 index, for 2+ decades straight? Only a handful like Warren Buffet. And no disrespect to the legend, but besides his hard work and acumen, there are always outliers in statistics for even improbable or uncontrollable factors. Could someone flip heads 50 times in a row. Absolutely! Very unlikely, but entirely probable. There is a reason Warren Buffet advises index fund investing. The returns you would have seen from passive index fund investing over Buffet’s career would have made you a millionaire many times over anyways.
Instead of Dollar Cost Averaging, focus on…
- Spending much less than you earn
- Hustling to increase your income
- Increasing your savings rate
- Passively investing in US index funds
This combination has historically proven to be an exponential creator of wealth, no matter your starting point or career path. And there are no clear shifts in the market proving it still isn’t. After all, we’ve seen incredible market crashes over the past 75+ years and each time the economy in general, and businesses in particular, come back.
Of course, if you are a business owner, there is the potential that re-investing in your business provides the greatest returns. But it is also placing all your eggs in one basket. Eventually you should diversify in the stock market, real estate not associated with your primary income, etc.