Investing a fixed amount at regular intervals produces an average cost per unit that sits below the average price over the same period. The reason is mechanical rather than clever.
Fixed sums buy more when prices fall
A constant contribution buys a variable number of units. When the price is low the same money acquires more of them; when it is high it acquires fewer.
The purchases at low prices therefore carry more weight in the final holding than the purchases made at high prices.
Buying a fixed number of units instead removes the effect entirely, because each purchase then contributes equally regardless of what was paid.
The average cost sits below the average price
The result is the difference between two ways of averaging. The simple average of prices treats each period equally; the average cost weights each by units acquired.
Because more units are bought at lower prices, the weighted figure is pulled downward. The gap widens as price volatility increases.
In a market that moved steadily in one direction with no fluctuation, the two averages would nearly coincide and the effect would disappear.
What it protects against and what it does not
The approach limits the consequence of committing everything immediately before a decline. No single purchase determines the outcome of the position.
It offers no protection against a market that falls throughout the whole contribution period. Averaging into a persistent decline still produces a loss.
It also does nothing about the choice of asset. Spreading the timing of a bad selection simply spreads the same problem across more dates.
Investing a lump sum usually wins on expectation
If markets rise more often than they fall, then holding cash while phasing money in means being out of the market during periods that were more likely up than down.
On that reasoning, deploying an available lump sum immediately has the higher expected outcome, and studies of historical periods generally point the same way.
Phasing in trades some of that expectation for a narrower range of outcomes, which is a legitimate preference rather than a mistake.
The behavioural reason it persists
Most people are not choosing between a lump sum and instalments at all. They are investing from income as it arrives, so regular contributions are the only option available.
For those who do hold a lump sum, phasing it in reduces the chance of a large immediate loss producing an abandoned plan.
A slightly lower expected return from a strategy that survives contact with a downturn beats a higher one from a plan that gets abandoned partway through.