What is dollar-cost averaging?
Dollar-Cost Averaging (DCA) is an investment strategy that purportedly removes the ’emotional’ factor in investing and mitigates the risk of badly timed trades.
The term was popularised by Warren Buffet’s mentor, Benjamin Graham, in his book, The Intelligent Investor.
It has been used by many investors, both amateur and professional, and works on a simple principle: invest a fixed amount of money on a regular basis over set intervals (i.e. every week) regardless of market conditions and then take advantage of long-term price.
While this investment strategy has often ben applied to the stock market, it is now being adopted by crypto investors to build wealth over time.
- Dollar-cost averaging (DCA) involves investing pre-determined smaller amounts at regular intervals over a set period of time as opposed to a larger lump-sum investment
- DCA can help investors avoid making “emotional” decisions in response to market swings
- DCA may be especially useful in markets that have high volatility, hence why it can appeal to many crypto investors
How does dollar-cost averaging work?
Dollar-cost averaging is a strategy that helps minimise the risk of investment losses by breaking down the total amount to be invested across periodic purchases over time.
There are two main options when choosing to invest. Investing all your money at once as a lump sum investment, or contributing smaller amounts of money over regular intervals.
The DCA Strategy means that the investor will be buying at a variety of prices, which should average out to the price at which the target asset is purchased, or better.
An example of DCA in action
Say you have $12k you want to invest. Your options are:
- Lump-sum investment: put all $12,000 into the asset (or assets) of your choosing
- Dollar-cost averaging: invest $1000 into an asset at a pre-determined interval i.e. every month
You’ve still invested the same sum of money after 12 months, but the outcomes may be different.
Does dollar-cost averaging work for cryptocurrencies?
Short answer: yes.
The dollar-cost averaging strategy can be applied to most sectors and markets with varying degrees of success. The strategy is especially useful in the crypto market, where timing the market can be difficult and the market can be highly volatile.
With DCA you can minimise the risk of poor timing and maximise exposure to the market. By balancing volatile price movements with averaging costs across a larger period of time, risks become more manageable. Your portfolio is increasing in value when the market is going up, but it can also decrease in value during down markets. When this happens, as long as you keep investing, you’re gaining more crypto assets at a discount.
Is dollar-cost averaging an effective investing strategy?
While you could argue this is a matter of opinion, there are certainly times that DCA is more effective than other investing strategies.
Markets that are inclined to be more volatile typically can benefit from this strategy. Dollar-cost averaging helps investors get in at a good price and limit their losses if they would have invested on a “bad” day. It’s best not to buy crypto assets just before a market downturn or pick up assets from the peak of a bull market and then go into a bear market.
Of course, it can be difficult to make these predictions. Hindsight will be the only way we know whether or not it is a “good time to buy”. DCA mitigates the risk of an extreme outcome, be it negative or positive.
Although the concept is easy to understand, it takes discipline and self-control. You’re less likely to make emotional decisions if you are forced to invest over a period of time.
Use a dollar-cost averaging calculator
To get a better understanding of dollar-cost averaging in action, you may want to try a DCA calculator.
Although a DCA calculator will not predict the future when it comes to the price of an asset, it can show the benefits of utilising this investment strategy overtime.
Cryptohead has a useful Bitcoin DCA calculator which has been used for the demonstration below.
Input your crypto asset, fiat currency, fiat value and frequency alongside the start and finish date.
In this case, we’re looking at BTC if you were to invest in January 1st, 2014 through to August 1st, 2021.
If you’d invested $10 AUD weekly over that period of time you would have invested a total of $3,860 dollars. You would have accumulated, however, $206,776 worth of Bitcoin (or 3.363 BTCs).
Pros & Cons of DCA
Investing your money all at once, or setting up an investment plan over time both carry risks.
There are pros and cons to each, and dollar-cost averaging is no exception.
Let’s start with its benefits though.
Benefits of dollar cost averaging
Two of the biggest benefits of DCA are:
- Risk mitigation
- It requires a smaller initial investment
By dividing your investments into equal intervals and also being aware of potential market shifts that could rapidly affect the value of large investments, you can reduce the risks associated with investing.
By having a dollar-cost averaging strategy in place, you can invest at regular intervals, typically monthly, regardless of market conditions. This means that even if prices are rising or falling you can invest as normal without worrying about making big investment decisions based on emotions like greed and fear.
This also ensures that your average cost price, the final price you pay per unit of an asset purchased over time, is more likely to be at your desired purchase price even if prices are rising or falling.
This hedges against sharp market fluctuations, and can also help build good investment habits.
Detriments of using dollar-cost averaging
A key detriment of DCA is that often the value of cryptocurrencies rise over the long term. While DCA hedges against risks, the returns on a ‘good investment’ in crypto with dollar-cost averaging would likely be less than had you invested a lump sum at the start.
Dollar-cost averaging also cannot replace being able to identify genuinely good investments. Yes, seeing market dips and spikes can lead to rash decisions, but there’s also a time and place for well-informed estimates when it comes to buying crypto assets.
For instance, if a certain cryptocurrency is about to make a development that will likely result in a large increase in value in the short term, you may then want to invest more into that particular digital asset, which is not an approach that DCA allows for.
[SNIPPET]: Important to remember: In markets that are less volatile or have a history of increasing over time, DCA may not deliver the returns an initial lump-sum investment would have.
Should you try the DCA strategy when buying crypto?
If you’re considering buying cryptocurrency, one of the most important things to keep in mind is that they are often volatile and unpredictable. This makes it all the more difficult for investors who want to avoid risk at any cost.
However, dollar-cost averaging can help mitigate some of those risks while still allowing you to invest – even if only a little bit each month or week. This can be especially useful for beginners still familiarising themselves with the crypto market, as it requires much less of an initial investment.