7 Mistakes to Avoid with Dollar Cost Averaging

Investors don't always understand how to use this investing method to their advantage.
By Dawn Reiss

A strategy that works – if you follow the rules.
As a way to minimize the risk from market fluctuations, dollar-cost averaging has its benefits. The strategy requires investing the same amount regularly (typically monthly) regardless of the price of an investment to lower its average cost per share and reduce the risk of buying at the most inopportune time. "It works remarkably well when the rules are followed," says Brandon LaValley, the Colorado Springs, Colorado-based director of financial planning for Targeted Wealth Solutions. Unfortunately, most investors don't follow the rules, says Clifford Caplan, founder and president of Neponset Valley Financial Partners in Norwood, Massachusetts. Here are seven ways investors often sabotage dollar-cost averaging.

1. Failing to recognize the benefits at an early age.
Seeding the market with small sums regularly is ideal for younger investors who often have only a little income to spare for investing, Caplan says. Plus, the method instills discipline, a valuable trait for investors to learn at a young age. It teaches them to "stay the course" particularly during bear markets, which offer the chance to buy shares more affordably, he says. Over time, the benefits of systematic investing become evident as the account continues to grow despite the "vagaries of the market," he adds. Even experienced, older investors may welcome how dollar-cost averaging can help insulate a portfolio from market volatility.

2. Not investing consistently.
Whether you invest a set dollar amount or a percentage of your income on a regular basis, do it the same way each time. Otherwise, you'll end up saving at different ratios, which defeats the purpose of dollar-cost averaging, that of helping to smooth out the effects from the market's peaks and valleys. "We recommend doing a flat [dollar] amount every month because it's easier to remember and keep track of," says Russell Robertson, owner of ATI Wealth Partners in Atlanta.
3. Forgetting to rebalance.
This is the most common mistake dollar-cost-averaging investors make, LaValley says. A portfolio invested in, for example, 60 percent stocks and 40 percent bonds will be out of balance after a year like 2017, when stocks have soared. As a result, an investor will end up with a much more stock-heavy portfolio and a riskier allocation than was intended, he says. The reverse is also true. A down-market year could result in a more conservative portfolio than planned, one that isn't as well-positioned to capitalize on the gains when the market inevitably rebounds. Experts recommend rebalancing a portfolio back to its original targets at least once a year.
4. Abandoning the strategy at the worst possible time.
An investor who is scared off by a turbulent market might think it's OK to take a break from dollar-cost averaging. But if you abandon the practice, your investing methodology becomes more about trying to time the market and chase returns, the two things financial advisors tell their clients not to do. An investor who a year ago stopped a dollar-cost-averaging plan that invested in emerging markets would have missed a 30 percent or higher appreciation on additional investments, Caplan says. "For it to be successful investors must stick to the system," says Ann Zuraw, president of Zuraw Financial Advisors in Greensboro, North Carolina. So pick how you want to invest, weekly, monthly or quarterly, and then follow through, she says.
5. Being too hands off.
Sticking to a plan isn't the same as being disengaged. Sometimes a dollar-cost averaging strategy needs an emergency brake. A stop-loss order for selling an investment is set up in advance and triggered when the price drops by a predetermined amount. Stop-loss orders are unnecessary if you're dollar-cost averaging into a dividend-producing fund or an exchanged-traded fund that invests broadly in the market, Robertson says, but if you are buying shares of a stock, set a limit order that takes effect if the stock drops by, say, 20 percent or some other amount. "If you watch it go down and don't sell it, you can lose more," he says.
6. Taking too long to invest a lump sum.
Ironically, investors may be more inclined to use dollar-cost averaging when it least benefits them. A Vanguard study found that a lump sum invested all at once produced higher returns about two-thirds of the time than if the money had been invested in 12 monthly installments. Still, because Vanguard found that dollar-cost averaging minimized losses in the worst markets, the method has merit for cautious investors who want to limit short-term risk. But even then, don't take more than a year to invest all the money, the Vanguard report says. Otherwise, by keeping cash on the sidelines too long, you miss out on the gains from putting those dollars to work.
7. Ignoring trading costs and transaction fees.
Because dollar-cost averaging requires buying into the market regularly, trading costs will add up if you're not paying attention and can vary drastically by brokerage, Zuraw says. Typically, costs are the least for stocks and exchange-traded funds, which can be less than $5 a trade. Trading fees for some mutual funds are substantially higher, more than $75 at some brokerages. Keep in mind that a fund with lower trading fees may have larger expense ratios, and account balances below a certain threshold may be charged higher trading costs or an account service fee. Trades made through a 401(k) shouldn't have trading fees, but double-check, Zuraw says.