It’s widely popular in the financial media to encourage the strategy of dollar-cost averaging (DCA) when investing. It’s a simple strategy that calls for investing the same dollar amount at regular intervals. When you assume that stocks or other investments at lower prices are bargains, dollar-cost averaging allows you to buy more of an investment when the price is better (lower), and less of an investment when the price is higher.

For example, consider someone who invests $100 into a broad index fund or ETF every month on the first day of the month. The price of the index, driven by the market, on January 1 is $10, so $100 buys ten shares. The price on February 1 is $12.50, so at this worse price, $100 buys only eight shares. You’ve received a better deal for a larger portion of your shares than you would have if you kept the number of shares you purchased steady rather than the dollar amount. In other words, if your other option was splitting the eighteen shares over two months, buying nine in January and nine in February, your gains would be lower.

This is, of course, a simplification of the issue. Many people often argue that, under the assumption that the stock market generally rises over long periods of time, you’d almost always be better off by buying the full eighteen shares as early as possible — in this case, January 1. Assuming the values trend upwards, that’s always the case — or at least it averages out to be over time. Many financial gurus then suggest forgetting about the idea of dollar-cost averaging and turn towards investing a lump-sum as soon as possible.

Reality gets in the way of that idea, unfortunately. Over my lifetime, I might invest $1 million. I have no idea of that will be true of course, because I cannot predict my future, but it’s a good figure to start with. Of course I’d be better off investing that $1 million at the moment I am legally allowed to do so, while just letting the account grow (on average) over large swaths of time. In fact, isn’t this the dream of every time-traveler? “If I could just take the $100 I have now, put it in the bank in 1795, and show up to collect the proceeds this year, I’d be a multi-millionaire!” Those who prefer gambling might be interested in taking Grays Sports Almanac: Complete Sports Statistics 1950-2000, a surprisingly thin compendium, back to 1955 and placing bets. (Come to think of it, Biff Tannen from the alternative 1985 reminds me a little of Donald Trump. Is it just me?)

Comparing lump-sum investing with dollar-cost averaging is not feasible most of the time. Thanks to reality, most of us are not time-travelers. We cannot take the amount we intend to invest over our life time and do it all at once at the beginning. You can, however, use leverage to invest more than you can afford to take advantage of these gains, but your returns will be hurt by the interest you pay on this debt and it amplifies your risk to often unacceptable levels. No, most people don’t invest using a lump sum because they need to earn the money they plan to invest through income, and that generally happens over time.

Furthermore, the more frequently buy an investment, the possibility for racking up transaction fees is higher, and these eat into your profits quickly. That’s a negative aspect of DCA, and it’s avoidable by dealing only with low-cost investments.

Dollar-cost averaging is effective because it allows people who can only budget for a small amount of investing to buy more shares of their investment when prices are lower. Most people can’t afford to invest in a lump sum.

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Pop writes about the intersection of our lives and economics at Pop Economics. There, you can find biweekly posts on everything from how your behavior affects your personal finance decisions to what the Fed’s most recent move means to you — not to mention some killer pop art. He recently wrote: Resistance is futile: Why buy-and-hold beats value investing.

The fact of the matter is: Most of us dollar-cost average when we invest because we have to. We get paid biweekly or monthly, and we invest our savings as soon as we receive it. We don’t have gigantic piles of money sitting around that we must choose to invest in a lump or over time.

But because dollar-cost averaging is personal finance 101, you’re going to find arguments as to why it’s the “best” way to invest anyway all over the place.

The refrain goes something like this: Let’s say that rather than put all your money into a mutual fund at once, you invest a set amount, say $1,000 per month, over time. When the fund is at $100 per share, you’ll buy 10 shares. When it’s at $150, you’ll only buy 7 or so shares. That way, you force yourself to buy more shares when they’re cheap and fewer when they’re expensive! You’ll see that argument at lots of reputable sites.

The problem with that explanation is that it suggests if you did have the choice between investing over time or all at once, you should invest over time. That doesn’t make sense, and here’s why.

1. Dollar-cost averaging works in reverse when you retire anyway.

Just as you might put $1,000 per month into stocks when you’re in the wealth accumulation stage of your life, you’re going to withdraw, say, $10,000 per month from your portfolio when you retire. And yes, that means you’ll be selling more shares when they’re cheap and fewer when they’re expensive — just the opposite of the supposed benefits dollar-cost averaging gave you when you started!

2. When you rebalance your assets as you age, it’s unrealistic to keep the strategy up.

Most of us invest a lot in stocks when we’re young and less in stocks (and more in bonds) as we age. Conventional wisdom holds that you should have, say, 90% in stocks and 10% in bonds when you’re in your 20s, but closer to 40% in stocks near retirement. But how do you get from one allocation to the other?

Dollar-cost averaging would seemingly dictate that you should slowly re-balance your portfolio as you age every month. In other words, when you hit, say, age 30, you’d sell a bit of your stock portfolio and buy a little bit of bonds each month as you got older. Aside from falling into the trap described in point one, how many of us could keep that up? And if we could, the transactional costs associated with the process, such as commissions from trading ETFs, would eat into our savings.

3. If you do have a lump-sum to invest, and choose to dollar-cost average, you’re throwing your asset allocation off, big time.

Pretend you’re in your 30s, have $100,000 saved so far in a 80/20 stock/bond mix, and come into a $100,000 inheritance. Hearing of the merits of the dollar-cost average approach, you choose to trickle the money into the stock market over time.

Well guess what? On day one, your asset allocation would be 40% stocks, 10% bonds, and 50% cash. Not exactly the aggressive asset allocation you intended, right? Just because you mentally put the $100,000 inheritance into a pile of money separate from your retirement savings doesn’t make it actually so.

And if you believe the stock market generally rises over long periods of time. The short-term volatility you’re trying to smooth out doesn’t matter anyway. The best time to invest will always be ASAP.

Something dollar-cost averaging is good at

At the end of the day, the completely rational individual would choose to make a lump-sum investment instead of to dollar-cost average. But exactly zero of us are completely rational. So there’s one big reason I can see someone choosing the DCA route, despite the arguments against.

In two words: “Loss aversion.” Humans fear losses more than they love gains. This tendency is well-documented by economists. So if you invested all $100,000 in a lump sum and the market dropped 5% the next day, you’d leave with an emotional scar. But alternately, if you began a DCA program and the market rocketed 5% the next day, you wouldn’t be nearly as sad.

That’s not rational — but it is the way we think. If you can’t get over that hump, you might decide that the cost of dollar-cost averaging is worth your emotional well-being. Just don’t pretend it’s making you money.

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