There are different ways to invest your hard earned money for example you can invest in stocks, or bonds or mutual funds etc. One method of investing which is totally different from all others is known as the Dollar Cost Averaging or DCA method of investing. In this article we will explain what DCA is all about:

DCA or the dollar cost averaging is a technique where the investor instead of using a lump sum amount to invest in an asset, uses dollar amounts to invest regularly in that asset. It is also known as Constant Dollar Plan or Unit Cost Averaging technique. In the UK it is more popular as Pound Cost Averaging. Here the investor doesn’t give any regard to the price of the stock. What the investor does is that, he/she slowly over a period of time buys the stock for a certain dollar amount. This the investor does to avoid the risk of market volatility.

The investor for example uses one hundred dollars or five hundred dollars every six months to purchase whatever asset he/she is interested in and in any number he can get them. This way the investor can buy stocks at lower prices and higher prices during a long time. When prices of the stock are less the investor gets more stocks for the dollar amount and when the prices of the stocks are high, he gets fewer stocks for the same dollar amount.

The rationale behind this technique is to reduce the total average cost per stock for the investor in his investment. It makes sense to investors who are generally weak at heart and are always nervous about the market volatility. This is because the DCA technique decreases the market risk of the investor through its systematic buying plan with a fixed amount.

There are three important parameters for a dollar cost averaging plan. These include- the fixed dollar amount of investment, the frequency of investment whether monthly, quarterly or half yearly and finally the period of investment such as for 1 year, 5 years, 10 years etc. The most preferred period for investment is usually 1 year.

Many might argue that dollar cost averaging technique is same as contributing to a retirement plan such as 401 (k). Even though it is similar to such plans, there are differences. Here you are not investing a lump sum unlike you do for retirement plans in the form of contributions. A limiting point of DCA technique however is the transaction cost inherent to it.