Dollar-Cost Averaging
Dollar-cost averaging commits a fixed dollar amount to the market at regular intervals, regardless of price. The mechanism is quietly clever: the same dollars buy more shares when prices are low and fewer when prices are high, which pulls the average cost per share below the average price paid over the period.
The math
Suppose a hypothetical investor puts $1,000 into a stock each month for four months.
| Month | Share price | Shares bought |
|---|---|---|
| 1 | $50 | 20 |
| 2 | $40 | 25 |
| 3 | $25 | 40 |
| 4 | $50 | 20 |
The total: 105 shares for $4,000, an average cost of $38.10 against an average price of $41.25.
At the final $50 price the position is worth $5,250, a $1,250 gain, and the crash month did the most work: the $25 purchase alone contributed 40 of the 105 shares.
The trap
Two different mistakes share the name. The first is averaging a lump sum into the market over many months out of fear: since markets rise more often than they fall, that caution usually costs return, and it is really loss aversion wearing a process costume.
The second is “averaging down” into a single deteriorating business, mistaking a falling price for a rising bargain. Fixed intervals do not sanctify a broken thesis; they just automate adding to it.
The move
Use dollar-cost averaging for what it genuinely does: putting each month’s new savings to work without a market-timing opinion, and enforcing purchases in the exact months when buying feels worst. A stock picker layers judgment on top.
Adding to an existing position on weakness is only justified when the thesis is intact and the business, not just the price, checks out; the discipline of re-verifying before each addition separates averaging into value from averaging into trouble.
Reference: SEC investor.gov