Chapter 12
Dollar Cost Averaging: A Smoother Path Through Volatility

Let’s rewind to the year 2000.

You’re a new investor. Everyone around you is talking about tech stocks, IPOs, and the “new economy.” The Nasdaq is exploding. You’ve saved up for years, and you finally put a large chunk of your money into the market — just in time for the dot-com bubble to burst.

Over the next two years, your portfolio plummets more than 50%. Panic sets in. You feel like you did everything right… but the timing was wrong.

Now imagine an alternate path — one that started even earlier.

In February 1993, you began investing just $1,000 a month into SPY. You continued through the dot-com crash, the 2008 financial crisis, the COVID panic, and every market storm that followed. Every dip gave you more shares. Every rebound rewarded your discipline. You didn’t try to time the bottom. You just kept showing up.

By mid-2025, you’ve invested $390,000 in total — and your portfolio is worth over $2.9 million.

That’s the power of Dollar Cost Averaging (DCA). It’s not about predicting the next big move. It’s about participating in the market with unwavering consistency — no matter what the headlines say.

In this chapter, we’ll dive deep into DCA, show how it performs when applied to SPY over 32 years, explain how to measure its returns accurately using XIRR, and compare it to Buy and Hold. Along the way, we’ll explore not just numbers — but mindset.

12.1 How Dollar Cost Averaging Works

Dollar Cost Averaging is deceptively simple: invest a fixed amount on a fixed schedule — most commonly monthly — regardless of market conditions.

The result is automatic behavior:

• When prices are high, you buy fewer shares.
• When prices are low, you buy more.

Over time, this naturally smooths out your cost basis. You avoid the risk of making a catastrophic lump-sum purchase at a market peak. And because the strategy is rule-based, it removes emotion from your investing process.

Most retirement plans, 401(k)s, and paycheck-based investing systems already use DCA by default — not because it’s flashy, but because it works.

12.2 SPY DCA Backtest Results (1993–2025)

Let’s look at what would’ve happened if you started a DCA strategy at the beginning of SPY’s history — investing $1,000 on the first trading day of every month starting in February 1993, and continuing through July 2025. All prices are adjusted for dividends and splits, reflecting total return.

Performance Overview

• Monthly contribution: $1,000
• Total invested: $390,000
• Final portfolio value: $2,900,974.24
• Total gain: 643.84%
• Annualized return (XIRR): 10.40%

Unlike a lump sum strategy, DCA introduces new money each month. That makes traditional return measures (like CAGR) misleading — because not all capital was invested at the beginning. This is where XIRR comes in.

12.3 Why We Use XIRR (Not Just Gain)

DCA creates irregular cash flows: each monthly contribution starts a new “mini investment,” held for a different length of time. To properly measure this, we need to account for the timing of every cash flow — not just the total gain.

XIRR (Extended Internal Rate of Return) does exactly this.

It calculates the annualized rate of return that would turn your series of monthly investments into the final portfolio value, taking into account:

• The exact date of each investment
• The final account value (as a cash-out flow)

This mirrors how your actual money behaved — and tells the truth about the performance you experienced as a real investor.

We use XIRR for every DCA strategy. It’s the only way to fairly compare performance across different time windows and contribution schedules.

12.4 Drawdowns and Investor Experience

Even with DCA, you’re not immune to market downturns. The worst drawdown in this backtest occurred during the 2008 financial crisis:

• Peak: $371,454.77 (2007-10-09)
• Trough: $176,675.05 (2009-03-09)
• Drawdown: 52.44% over 517 days

This is slightly smaller than the Buy and Hold drawdown of 55.19%, despite the same market environment. Why?

Because with DCA, you keep buying even as prices fall. Your ongoing contributions soften the impact and accelerate the recovery. This makes DCA more psychologically manageable — you’re not watching one large sum collapse, you’re steadily building through it.

12.5 Risk-Adjusted Return: Calmar Ratio

To measure return per unit of risk, we again use the Calmar Ratio:

This is slightly higher than Buy and Hold’s 0.19 — a subtle but important edge. While the return is marginally lower, the smoother ride makes DCA easier to endure.

12.6 Buy and Hold vs. DCA: Which Is Better?

Both strategies delivered strong results over the long run. Here’s a side-by-side comparison:

Buy and Hold had a slight edge in raw return — but required full upfront investment and a greater ability to tolerate volatility. DCA came close in return, slightly edged out in risk-adjusted performance, and offered a more emotionally durable experience.

In bull markets with low volatility, Buy and Hold shines. But in volatile, uncertain environments — especially when you’re investing new money over time — DCA may be the safer and more sustainable path.

12.7 Behavioral Edge: Why DCA Is Easier to Stick With

One of DCA’s greatest strengths is psychological.

When you invest all at once, you’re constantly second-guessing:

• “Was that the top?”
• “Should I wait for a better entry?”
• “Should I sell now to avoid further loss?”

With DCA, those questions vanish. You have a plan. You execute it. You let time do the work.

This consistency helps you stay invested — and staying invested is more important than perfectly timing your entry.

12.8 DCA Isn’t Always the Right Answer

While Dollar Cost Averaging has many advantages — especially in volatile or uncertain markets — it’s not a universal solution. One of the most common misuses of DCA is applying it to a large lump sum of money. If you have $1 million ready to invest and choose to trickle it in at $1,000 per month, you’ll need more than 80 years to fully deploy your capital. That’s not just inefficient — it’s financially reckless.

In historical bull markets, lump-sum investing tends to outperform DCA. The reason is simple: the sooner your money is in the market, the longer it can compound. By holding large amounts of cash on the sidelines, DCA can act as a drag on performance — especially when interest rates are low and inflation is high.

Some critics argue that DCA is “as stupid as it sounds” when misapplied to lump sums — and there’s a point to be made. DCA isn’t designed to maximize returns. It’s designed to manage behavioral risk — fear, hesitation, regret. It’s a tool for consistency, not optimization. For investors who are still accumulating capital from their income, or who are hesitant to invest all at once due to market timing concerns, DCA is useful. But for those with high conviction and the ability to withstand market swings, getting invested sooner is often the superior choice.

12.9 Final Thoughts

Dollar Cost Averaging is not a performance hack — it’s a psychological framework.

It’s about removing emotion from your investment schedule and showing up consistently. It transforms volatility from something to fear into something to harness. For people investing as they earn — month by month, paycheck by paycheck — it’s a practical, intuitive way to build wealth over time.

But it’s not a magic bullet. In rising markets, slow entry means missed opportunity. And when large amounts of capital are sitting idle, it can be more costly than comforting.

Ultimately, DCA is a behaviorally aligned strategy that works because it’s realistic. It acknowledges that most investors aren’t trying to be perfect — they’re just trying to be disciplined.

In the next chapter, we’ll shift from passive accumulation to active decision-making. We’ll begin exploring tactical strategies — starting with one of the most time-tested concepts in technical analysis: when price crosses a moving average.