9 - Dollar-Cost Averaging

In my last post, I explained the P/E ratio and how investors use it to find which stocks are suitable for their investment. Here, I will discuss an investment strategy rather than a tool: dollar-cost averaging.

Dollar-cost averaging (DCA) is a strategy where the same amount of money is placed into the same stock in regular intervals over a certain period of time. Even with tools such as the P/E ratio, investment is tricky in that there is no way to tell which stocks will rise or fall, meaning everything has to be inferred. Trying to time the market is abundantly difficult for any investor; therefore, to mitigate high share costs, DCA was invented.

Dollar-cost averaging works best in passive investment. If you spend your entire savings at once, you immediately feel the effects of the market. As a result, putting small increments of money in regular intervals has a lower risk factor than going all-in on an investment. While you may take better advantage of market growth, a market crash is sure to deplete large amounts of money at once. This leads to DCA, where the smaller deposits lead to crashes having less influence when they occur.

Furthermore, because the process is fully automated, dollar-cost averaging also limits the emotional factor of investment as investors can easily ignore their investment knowing money is dumped into an investment per interval. Consequently, dollar-cost averaging is viable for those who may be emotionally affected by large losses.

Dollar-cost averaging, however, is not without its shortcomings. Because you’re not investing larger amounts of money at a time, any gain is limited to what is already invested, meaning DCA yields less returns. Any money that isn’t invested is sidelined, meaning the investment is not the most efficient. As seen in my previous posts, the market trends up - as a result, DCA misses out most of the time. Furthermore, investors actually have to find a stock to use DCA; doing DCA on a failing stock is as pointless as going all-in on a stock because DCA expects sizable returns in addition to low average costs.

As of today (February 9, 2025), there has been a market high in the S&P 500 for a while now. Due to its extraordinarily high P/E ratio, many are fearing a crash. Here is a video detailing the rise of S&P 500 and a further explanation of dollar-cost averaging:

DCA, especially on an index fund such as the S&P 500, is a passive yet viable strategy to gain money through investment. On most years, the S&P 500 can beat most active funds. Pursuing a more active strategy, however, can still be considered and if an investor conducts enough research and has enough patience, they can still beat the S&P 500 and DCA.