What is dollar-cost averaging? (with a worked example)

How dollar-cost averaging works

Dollar-cost averaging is the habit of investing a fixed amount of money at regular intervals, regardless of what the market is doing. In Europe you'll also hear it called euro-cost averaging, and in the UK pound-cost averaging. Vanguard notes the idea is the same in every country.

Say you set up an automatic €100 investment into an ETF (exchange-traded fund) on the first of every month. Some months the price is high, some months it's low. You don't decide; you just buy.

The maths has a quiet advantage. A fixed amount buys more units when the price is low and fewer when it's high. So you end up owning more of the cheap units than the expensive ones, and your average cost per unit comes out below the simple average of the prices you paid.

A worked example: €100 a month

Here are six months of €100 purchases while the price falls and then recovers:

The price ended exactly where it started, at €20. Yet because you kept buying through the dip, your €600 became €810. Someone who invested all €600 in month one would have bought 30 units, worth €600 at the end: no gain at all.

That's the best case for dollar-cost averaging: a fall followed by a recovery.

When the price only goes up

Now take a different six months, where the price rises steadily: €10, €12, €14, €16, €18, €20.

• €100 a month buys 42.28 units at an average cost of €14.19. At €20, that's worth €845.63.
• €600 all at once in month one buys 60 units at €10. At €20, that's worth €1,200.

Here, spreading the money out cost you about €354. When prices rise, money waiting in cash misses the growth. And historically that has been the more common case: Vanguard found that from 1976 to 2022, US stocks beat cash 76% of the time.

Dollar-cost averaging vs lump sum: what the research says

The real choice only exists if you already have a lump sum, say from an inheritance, a bonus or a house sale. If you invest from your salary each month, you're dollar-cost averaging by default.

Vanguard studied this question in a 2023 paper. It compared investing a lump sum straight away with splitting it into three equal parts invested a month apart, using world stock market returns (the MSCI World Index) from 1976 to 2022. Its findings:

• Lump sum beat cost averaging 68% of the time, measured one year later.
• Cost averaging beat staying in cash 69% of the time. So spreading it out is still better than not investing at all.
• For a 60% shares, 40% bonds portfolio, a lump sum ended the year about 1.8% higher on average.
• In the worst markets, cost averaging did better. Lump-sum investing exposes all your money to a fall straight away.

Vanguard's conclusion was that most investors are better off investing a lump sum immediately, but that cost averaging may suit people with a strong aversion to losses, who might otherwise leave the money in cash.

When each approach fits

Regular monthly investing fits when:

• You're investing from your salary. There's no lump sum to decide about.
• You want an automatic habit that doesn't depend on reading the news.

Investing a lump sum at once fits when:

• You have the money now, a long time horizon, and can sit through a fall without selling.
• You accept that, on the historical record, it has usually come out ahead.

Spreading a lump sum over a few months fits when:

• A sharp fall right after investing would make you panic and sell.
• The regret of bad timing would put you off investing for good.

A plan you stick to beats a better plan you abandon. ESMA, the EU markets regulator, also reminds investors to think about their goals and time horizon before choosing anything.

How to set up dollar-cost averaging

The whole point is that it runs without you, so set it up once and let it work:

1. Choose your amount. Pick a monthly sum you can keep up in good months and bad ones. A smaller amount you never skip beats a larger one you keep pausing.
2. Choose the day. A day or two after payday works well, so the money leaves before it gets spent.
3. Choose the investment. Regular investing suits broad, low-cost funds. Our guide to index funds vs individual stocks explains why many people choose index funds.
4. Automate it. Set up a standing transfer from your bank and, if your broker offers one, an automatic investment plan that buys on a fixed date.
5. Review once a year. Check the fees, raise the amount if your income has grown, and otherwise leave it alone.

Common mistakes

• Stopping when prices fall. Falls are when regular investing buys the most units. Pausing then throws away its main advantage.
• Ignoring trading fees. A fixed €1 fee on a €50 monthly purchase is 2% each time. Our guide to how much money you need to start investing shows how to keep that down.
• Spreading a lump sum over years. Vanguard found the longer the cost-averaging period, the bigger the cost of missed growth.
• Thinking it beats the market. It changes when you buy, not what you earn from the investment itself.

Regular investing works best with a low-cost, widely spread fund. Our guide to what an ETF is explains the basics, and our investing for beginners guide puts it all together.