Explaining Dollar Cost Averaging in Crypto Investments
Dollar-cost averaging (DCA) is an investment strategy in which the intention is to minimize the impact of volatility when investing or purchasing a large block of a financial asset or instrument. It is also called unit cost averaging, incremental averaging, or cost average effect. In the UK, it is referred to as pound cost averaging. This allows you to profit from crypto market downturns without putting too much cash at risk at any particular moment, allowing you to maintain more liquidity and still profit from market increases.
Crypto investment has a peculiar trait — it is usually volatile
- Dollar-cost averaging refers to the practice of systematically investing equal amounts, spaced out over regular intervals, regardless of price.
- The goal of dollar-cost averaging is to reduce the overall impact of volatility on the price of the target asset; as the price will likely vary each time one of the periodic investments is made, the investment is not as highly subject to volatility.
- Dollar-cost averaging aims to avoid making the mistake of making one lump-sum investment that is poorly timed with regard to asset pricing.
It was found that the average cost was more than the initial purchase price but at the same time, it was lower than the fund’s top prices. This helped Joe make the most out of market fluctuations as the index fund flourished and then dropped down in value.
The Dollar Cost Averaging strategy generally operates on the assumption that market prices will eventually rise in the coming future. If this strategy is used on an individual stock without comprehending the details of the company; it can prove to be very risky as this may encourage investors to keep on buying stock at a time when they shouldn’t. This is also a better strategy for index funds instead of individual stocks for less-informed investors.
For those investors using a dollar-cost averaging strategy have to ultimately lower their cost basis while investing over time. This results in less losses on investments as they drop down their price thereby generating better profits on investments that appreciate in price.
Dollar-cost averaging is an investment strategy that works to decrease the amount of Bitcoins and in turn, minimizes risks. It works on simple reasoning that buying small amounts at regular intervals is always better than investing a big sum in a single go, irrespective of the price.
This technique makes your investment more simple, and practical therefore less emotional. Using dollar-cost averaging an investor can buy less when prices are inflated and buy more as they drop. This investment method is quite helpful for crypto investors who do not have a lot of money to invest initially.
Cryptocurrency belongs to a very dynamic market and as a result, the price volatility is a big disadvantage. Sometimes, waiting for the right time can make lose out on so many financial opportunities. A smart trader prefers dollar-cost averaging as it gives them a great avenue to evade market mis-timings rather than crying over spilled milk.
Benefits of Dollar-Cost Averaging
1. Risk reduction
Dollar-cost averaging (DCA) is a popular investment strategy to reduce investment risk as one can manage price movement risk by spreading one’s purchases over a period. In simple words, an investor buys small quantities at regular intervals rather than investing lump-sum money with one single purchase.
This is used as a very effective tool to trade especially in a declining market which is known to be a buying opportunity. As the prices keep falling, one can keep buying small quantities over time at regular intervals and with each purchase, the investor manages to average out the overall purchase price of the asset. DCA helps the investors in reducing the impact of price volatility as any sudden downside deterioration in a security price will no longer affect your portfolio. Hence, an investor can lower the investment costs while boosting the returns in the long run.
2. Lower cost
Buying market securities when prices are declining ensures that an investor earns higher returns. Using the DCA strategy ensures that you buy more securities than if you had purchased when prices were high.
3. Ride out market downturns
Using the DCA strategy by investing periodic smaller amounts in declining markets assists in riding out market downturns. The portfolio using DCA can keep a healthy balance and leave the upside potential to increase portfolio value in the long term.
4. Disciplined saving
The strategy of adding money regularly to an investment account allows disciplined saving, as the portfolio balance increases even when its present assets are depreciating. However, a prolonged market decline can be detrimental to the portfolio.
5. Prevents bad timing
Market timing is not a pure science that many investors, even professional ones, can master. Investing a lump sum at the wrong time can be risky, which can adversely affect a portfolio’s value significantly. It is difficult to predict market swings; hence, the dollar-cost averaging strategy will provide a smoothening of the cost of purchase, which can benefit the investor.
6. Manage emotional investing
The phenomena of emotional investing brought about by various factors — such as making a huge lump-sum investment and loss aversion — is not unusual in behavioral theory. The use of DCA eliminates or reduces emotional investing.
A disciplined buying strategy through DCA makes the investor focus their energy on the task at hand and eliminates news and information hype from various media about the stock market’s short-term performance and direction.
Here’s an Example
How Does It Work?
The dollar-cost average can be divided into two components — the fixed amount to invest and the regular interval to invest that amount.
For example, let us assume that the fixed amount to invest in is US$100. That is how you can afford to risk in the cryptocurrency market. In your first month, you spend US$100 to purchase a fraction of Bitcoin. As you keep investing that amount every month, you will notice that during some months, you will be able to purchase more Bitcoins because of price volatility.
This way if you have a five-year target, you will be consistently funding your investments for those five years and putting money in the market, rather than timing the right moment. This is an effective strategy in the cryptocurrency market. The same can be used for Ethereum, Binance coin, Ripple, etc. Another important aspect to remember here is to choose the right asset to invest in. This will require dedicated research and analysis. Dollar-cost averaging only works when you keep investing in one particular asset. Hence, choose the most reliable option to safeguard your investments.
Dollar-cost averaging (DCA) comes with benefits and drawbacks; however, the desire for a low-risk investment strategy may lead to lower returns.
On the benefits side, it’s possible to achieve a lower dollar-cost average for security over time rather than a lump-sum investment, provided there are declining markets that do not become protracted.
An investor should aim to include DCA as an optional strategy, among other bolder strategies such as target asset allocation, diversification, and regular portfolio rebalancing.