After a very difficult year for both bond and stock investors, markets have recovered significantly in 2023. Many investors trying to time the market will be wondering if it is again the right time to buy now. However, there is a different investment strategy which does not rely on market tinting but rather on constantly investing and building wealth in the long term: enter Dollar-Cost-Averaging (DCA).

In our guide, we will show you how to build a successful long-term portfolio by employing Dollar-Cost-Averaging in your investment strategy. 

Understanding Dollar-Cost-Averaging and how to use it with ETFs

The term 'Dollar-Cost-Averaging’ is a complicated explanation for a very simple investment strategy: it means saving but using ETFs, funds or other securities or financial assets rather than a savings account. By simply investing the same amount every month one can ‘average’ the cost of the stocks or ETFs one is investing in when the market has declined, you are able to buy a greater proportion of stocks or ETFs with the same amount you considered saving each month.

On the flip side, if the market has just reached new highs, the units you can purchase per month are lower; hence you reach an average price, which helps you build wealth in the long run, buying smoothing out peaks and troughs.

Why DCA is important

To outline the explanation with an example, consider the following: you are able to set aside $100 every month to invest in a diversified 60-40 portfolio containing an S&P 500 Index ETF (like the SPY) for equities and a long-dated US government bond ETF for your fixed income portion (like the TLT). 

At the beginning of the year 2023, the SPY was trading around $378 and the TLT around $97 and you keep purchasing units each month. 

At the end of July 2023, the SPY was trading around $457 and the TLT around $99. While the SPY has increased gradually, the TLT was going sideways. You have consequently continuously bought a smaller amount of SPY shares while the price was rising and an increasing amount of TLT shares when the price dipped.

As a result, you purchased more bonds when the price for bonds was more favourable, thus having a lower average price paid per unit of investment for both equities and bonds. 

The main benefits of Dollar-Cost Averaging are:

  • Mitigates market timing risks by spreading out investments over time
  • Forces discipline by investing consistently regardless of market conditions
  • Lowers average share cost over the long run

How Dollar Cost Averaging helps to keep emotions in check

Dollar-Cost-Averaging does not only have a mathematical advantage if prices fluctuate in the short run and rise in the long run but also a psychological one. It stops emotional involvement in making market timing and investment decisions.

By investing a fixed dollar amount at regular intervals, you stop emotional involvement like fear when prices are low and keep buying a bigger amount of shares. Conversely, greed and FOMO are kept in check when prices are high and you buy a smaller amount. This results in a lower average cost per share over time compared to investing a lump sum all at once, which may hit the market at a peak.

It is thus, an effective way to mitigate various investment risks:

  • DCA reduces market timing risk: Investing at regular intervals means you don't need to worry about when you’re actually buying. 
  • It minimises volatility risk: Because regular smaller investments smooth out market highs and lows over time.
  • Most importantly, it limits emotional involvement: By taking impulsiveness out of investing.

Dollar-Cost Averaging with ETFs: how to build long-term wealth

You can use a DCA strategy with any type of (liquid) financial asset, even single stocks or funds. However, ETFs are quite uniquely suited for this investment strategy. This is because they have a range of benefits compared to funds, single shares or trusts, such as:

  • Diversification to mitigate idiosyncratic risks of investing in single stocks.
  • Low expense ratios compared to actively managed mutual funds.
  • Range of markets offered like stocks, bonds, commodities and more. 

With their diversity and flexibility, ETFs are thus well-suited assets to utilise a Dollar-Cost averaging strategy.

How to implement a DCA strategy with ETFs

With the rise of online brokers and trading apps, it is quite easy to build a DCA portfolio yourself:

1. Decide on your ongoing contribution and frequency

First, determine a set amount you can invest on a regular basis, such as $50 or $100 per month. Then, decide on the frequency: weekly, monthly, quarterly, etc.

2. Open a brokerage account

You'll need a brokerage account to trade ETFs. Opt for one with low or no commissions to keep costs down. Many brokers now offer commission-free ETFs, but make sure to check their terms in detail.

3. Select ETFs

Research and select appropriate ETF(s) for your portfolio goals and risk tolerance. Focus on broad market index ETFs with low expense ratios. Avoid niche or leveraged ETFs. You can research ETFs like VUSA, VWRA and VUKE here on our website. 

4. Make investments

On your decided schedule, invest your set amount into your selected ETFs or use a DCA investment plan offered by your broker. Stick to the same ETFs instead of constantly changing them.

5. Reinvest dividends

Reinvest any dividends from the ETFs to compound your returns over time or pick ETFs that automatically reinvest dividends. Many brokers also offer automatic dividend reinvestment options.

6. Hold for the long term

Resist the urge to alter your investments based on market swings. Remain patient and consistent for long-term growth. Tune out short-term noise and focus on the long game.

The keys are consistency and patience. By investing at regular intervals over the years, you lower your average cost per share and mitigate market timing risks.

To sum up, dollar-Cost-Averaging is a well-understood way of building wealth that works extremely well provided asset prices rise in the long term and fluctuate in the short term, which has been the case in most of the recent history of financial markets. 

Combined with a strategy to create a diversified portfolio, such as building a 60-40 portfolio, it is a smart way of investing in the markets.

If you combine it with low-cost, high-liquidity ETFs that have exposure to a broad international basket of stocks, bonds and perhaps alternative assets, you can achieve a cost-efficient, diversified asset allocation and an ETF portfolio right for you.