Dollar-cost averaging is a powerful tool to mitigate risk in your investing. Combine this with the excellent products Vanguard offers and you’ve got a winning combination!
When I first started investing in Vanguard’s ETFs I had a sizeable amount of money to put to work. However, I wanted to spread out my investment with Vanguard through dollar-cost averaging. So, this is the strategy I came up with:
How does dollar-cost averaging with Vanguard work? You basically have three options. The first to simply manually invest a fixed amount every month through Vanguard’s brokerage platform. The second is to use Vanguard’s auto-invest feature which is available for all Admiral Share classes. And the third option, which I would recommend, is to use a third-party broker to auto-invest in fractional shares of Vanguard’s funds.
Let’s have a look at these options in a bit more detail!
What is dollar-cost averaging?
First of all: the basics. Put simply, dollar-cost averaging is the process of dividing up a lump sum of money you would like to invest into smaller chunks. You would then invest these smaller chunks at fixed intervals (commonly monthly) over time until your entire lump sum has been invested.
For instance, let’s just say somebody gave you $12,000 to invest (how nice!). If you would apply the dollar-cost averaging strategy to invest in Vanguard’s Total Market Fund (VTI) you could consider choosing a timeline of 1 year and invest $1,000 each month.
12 x $1,000 = $12,000
If you’d like to mitigate portfolio volatility even further you might also choose to pick a longer time frame and spread out that investment over 2 years at a rate of $500/month.
Does dollar-cost averaging work?
When examining whether dollar-cost averaging actually works, we first need to ask what its aim is. Then we know which metric to compare it to.
Most people who ask this question probably mean: does dollar-cost average yield higher returns than investing a lump sum of money. And the answer to this is – of course – it depends. Specifically, it depends on the market conditions and behavior at the time of investing and during the subsequent interval.
In most cases dollar-cost averaging will perform worse in terms of overall returns than lump-sum investing. (Read: How can dollar-cost averaging protect your investments?)
For brevity’s sake, all you should take away from is that dollar-cost averaging does work as intended: mitigating volatility in portfolio value.
It other words: dollar-cost averaging smooths the ride.
Dollar-cost averaging with Vanguard
But let’s move on to the real reason I am writing this article: investing in Vanguard funds through dollar-cost averaging.
As mentioned above, you’ll have basically three options of which the last one is my favorite. The first two use Vanguard as a broker and the third one makes use of a third-party broker such as M1 Finance to leverage the power of fractional shares and auto-investing.
Option #1: Vanguard (Manually)
This option is probably the easiest, especially if you are already using Vanguard as you broker.
For simplicity’s sake, let’s just stick with the $12,000 lump sum example from above. If we divide this into 12 equal investments of $1,000 each all we need to do is to login to your Vanguard account, select your favorite Vanguard ETF, and click buy.
The upside of this is of course that it is super simple to do and that you remain in full control of how much you invest each month.
The downsides are that it can be a bit time consuming to log in every time you want to buy a few shares of VTI. Furthermore, you will likely get emotionally involved when you have to execute the trade yourself and judge your investment based on the current market price. This can make it harder to stick to your dollar-cost averaging plan.
In both instances, it’s much easier to “set and forget”.
Option #2: Vanguard (Automated)
This next option also uses Vanguard as your broker but automates the entire dollar-cost averaging process.
For nearly every ETF that Vanguard has issued there is an Admiral Share counterpart in the form of a mutual fund. This term is a little misleading since Vanguard’s Admiral Share funds behave de facto more like index funds. (Read: Are Vanguard Admiral Shares Worth It?)
One of the many benefits of Admiral Shares – besides their lower fees – is the ability to automatically invest a fixed sum every month. You can set this up right when you make the initial investment on the Vanguard platform.
However, there still are some drawbacks. For one, the minimum amount you need to invest to access Vanguard’s Admiral Shares is $3,000. If we now think back to our previous example you would only be able to invest after month three (3 x $1,000 = $3,000).
Of course, you always have the option manually invest the first three month in the ETF version (e.g. VTI) and then switch to the corresponding Admiral Shares (VTSAX) after the third month.
But for the most part, I prefer simplicity. Which is why this third option is my favorite.
Option #3: Third-Party Broker (Automated)
This option is my favorite for a few reasons: it is simple to set up, requires no maintenance, and offers better returns.
There are plenty of third-party brokers that offer Vanguard funds to investors. You can do your own research in due time but for this article I’ll focus on the one I personally use: M1 Finance.
It’s as easy as depositing funds as you normally would and then choosing the option “switch to a recurring schedule“:
In addition to this ease-of-use, you will have the ability to invest in fractional share which means that your entire dollar-cost averaging plan will be executed down to the last dime. Every month you will be able to invest exactly $1,000 in one, two, or a portfolio of Vanguard funds:
The upsides here are obvious: you’ll won’t have the hassle of manually investing each month thanks to the auto-invest feature and you won’t have any remaining capital lying around because you are bound to the price of one share (e.g. if you want to buy VTI for $1,000 at the price of $150 per share you will only be able to invest $900).
There aren’t really any cons to this option in my opinion since you still get commission-free trades and no additional fees with a broker like M1 Finance.
Dollar-cost averaging with Vanguard can as simple or as hard as you want it to be!
I’ve presented three options above to combine the power of dollar-cost averaging with Vanguard’s products.
My ideal setup is to automatically invest a fixed percentage of my income into a three-fund portfolio of VTI, VXUS, and BND. You can do this manually through Vanguard, automatically with Admiral Shares, or add fractional share investing through another broker.
Whatever you choose to do, stay humble, foolish and curious.