I am putting this article as an opinion because I am not just explaining what dollar cost averaging is, I am also advocating for dollar cost averaging. I will still try to be as factual as possible. Also, I am not a financial advisor. Nothing in this article is or should be taken as financial advice.

Introduction

Here is a good definition of dollar cost averaging from a reliable source:

"Dollar-cost averaging (DCA) is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase. The purchases occur regardless of the asset's price and at regular intervals."

https://www.investopedia.com/terms/d/dollarcostaveraging.asp

In simple terms dollar cost averaging means buying small amounts of an asset periodically, so that if the price suddenly drops it’s not as big of a big deal.

Timing the Market

Dollar cost averaging is an alternative to "Timing the Market". Here is a good definition of Timing the Market from a reliable source:

"Market timing is the act of moving investment money in or out of a financial market—or switching funds between asset classes—based on predictive methods. "

https://www.investopedia.com/terms/m/markettiming.asp

Simply put, timing the market means trying to buy an asset when you believe its price is at or near its lowest point, based off some method that you think indicates the future price of that asset.

Example:

Let us investigate the gains from Dollar cost averaging Vs. Timing the Market.

Let’s say Billy, Sally, and Tyler all have $1200 to invest into a pretend stock.

Sally will attempt to Time the Market and will buy $1200 worth of the stock all at once. Sally will be lucky.

Tyler will also attempt to Time the Market and will buy $1200 worth of the stock all at once. Tyler will be unlucky.

Billy will Dollar cost average by buying $100 dollars’ worth of the stock on the 1st of every month.

Here is the price history of the made up stock for the year 2021:

Sally bought into the stock at its price bottom on July 1st, she spent $1200. On July 1st the price of the stock was $55 so she bought 21.82 ($1200/$55) shares of the stock.

Tyler bought into the stock at its price top on March 1st, he spent $1200. On March 1st the price of the stock was $133 so he bought 9.02 ($1200/$133) shares of the stock.

Billy bought $100 dollars’ worth of the stock on the 1st of each month, regardless of its price, here is a list of his transactions:

Billy bought a total of 13.06 shares over the year.

Example Continued:

Sally, Tyler, and Billy all spent a total of 1200 dollars. Here is a summary of all three individuals’ balances on December 1st:

Share Price on December 1st: $121

Sally:

Strategy: Timing the Market, with good luck

Owns: 21.82 shares

Shares Value on December 1st: $2640.22

Average purchase price: $55

Tyler:

Strategy: Timing the Market, with bad luck

Owns: 9.02 shares

Shares Value on December 1st: $1091.42

Average purchase price: $133

Billy:

Strategy: Dollar Cost Averaging

Owns: 13.06 shares

Share Value on December 1st: $1580.26

Average purchase price:$1580/13.06 = $120.98

Clearly Timing the Market with good luck had the best result, with Dollar cost averaging coming in second, and Timing the Market with bad luck coming in third.

If dollar cost averaging was not the strategy that resulted in the most gains, why do people do it? People dollar cost average , because it is very hard if not impossible to predict when an asset price will bottom. In our example, if Sally’s luck wasn’t as good, she could have bought the stock right before the price of it dropped drastically.

Billy on the other hand did not rely as heavily on luck. His method of investing simply relied on him assuming the stocks value will generally rise with time. As long as the price of the stock generally increased he would be profitable.

Conclusion

All investing relies on the fact that you believe the asset you are buying will increase in value at some point in the future. Dollar cost Averaging and Timing the Market are simply two methods to address the volatility one sees in the market of an asset.

Timing the market attempts to predict the volatility in a market by some method and use that prediction to buy an asset at its lowest price.

Dollar cost averaging on the other hand presumes that it is impossible or near impossible to predict how the market will change in the short term, so instead of attempting to buy at the lowest price, someone who is dollar cost averaging buys in periodically, unconcerned about short term volatility. Their only concern and presumption are that the price of the stock will generally increase with time.

In conclusion, if someone could somehow know when a stock will be at its lowest price then, they should buy in all at once. BUT since there is no method to predict an assets lowest price with 100% certainty (or even close to 100% certainty), many people feel that Dollar Cost Averaging is the safest and most effective investing strategy.