What is Dollar-Cost-Averaging (DCA)?
Definition
Dollar-cost-averaging is a strategy that automatically invests small amounts of money at a time (instead of a lump sum).
Understanding Dollar-Cost-Averaging (DCA)
Dollar-cost averaging (DCA) is a tried-and-tested strategy that is perfect for anyone who doesn’t have the time to study the markets for the best entry point. It also lowers you’re risk and saves you from risking too much capital at any one time by investing in smaller increments that are convenient for you.
With Dollar-cost-averaging you invest small increments over a long period of time, instead of all at once. DCA is a convenient way for investors wanting to invest a small amount from their paycheck each week, while getting a good average price on an asset without having to try and ‘time the market’.
Timing the market is notoriously difficult in, so DCA helps you flatten out market volatility and short-term fluctuations in asset prices. More often than not, DCA will end up getting you a better average entry price than if you tried to guess the best time to invest large amounts.
Benefits of DCA:
- Reduces the risk of timing your entry poorly
- Offsets the negative effects caused by short term market volatility
- Doesn’t require a big upfront investment
- Removes the stress of trying to ‘time the market’
- You can automate your buys & sit back while your portfolio is built
DCA is a low risk, low reward strategy that suits all kinds of investors. It works in pretty much all conditions and is perfect for a volatile market like crypto.
How does Dollar-cost-averaging (DCA) work?
DCA is a useful tool which you can automate using Digital Surge’s. Forget about bad timing and just enter in when you want to buy, how much and how often, then sit back and relax while your portfolio is built for you. The key to DCA is choosing an amount/frequency that’s affordable, and investing regularly no matter the price of an asset.
EXAMPLE
Rather than buying her portfolio all at once, Jane uses DCA to build her portfolio over a period of time, investing small amounts at regular intervals.
Let’s say she has around $10,000 dollars in total to put into crypto. She wants to build her portfolio over a period of two years so every week she automates a purchase of $50 of Bitcoin and $30 of Ethereum, which she calculates will cost her $8320 all up. The rest of the money she keeps aside in case a great opportunity pops up in the market.
While this will take Jane longer to assemble her total portfolio than if she invested it all in one go at the start, this is a strategy that has been proven over time to improve an investor’s average entry price.
The great thing about DCA is it’s fully customisable. If Jane sees a particularly promising altcoin somewhere down the track, she can throw in a little more money while keeping her Bitcoin/Ethereum DCA strategy strong, giving her the best of both worlds: Stability + the potential for some short term gains.
Key Takeaways
- Dollar-cost-averaging is investing in small chunks over an extended period of time, instead of in one lump sum.
- DCA removes the burden of FOMO (fear of missing out), emotional trading & trying to time the market
- The most effective way to use DCA is to use the ‘recurring buy’ feature, which automates your investments for you.
- DCA is often the best strategy for long term investments as it gets you a good entry price, protects you from market volatility & doesn’t require risking a lot of capital at any one time.
- DCA doesn’t completely mitigate risk. It just smooths your entry into the market so that the risk of bad timing is minimised.
- The key to DCA is choosing an amount that’s affordable and investing regularly, no matter the price of an asset.
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Why use DCA?
Over the long term, investing bit by bit is a better plan than constantly trying to guess the best time to enter the market (which can be very hit and miss unless you really know what you are doing). If you want a relatively safe way of benefiting from crypto’s infamous fluctuations, a dollar-cost averaging strategy is worth considering.
DCA doesn’t come with the insane gains you can make actively trying to time the market, but it is a highly recommended strategy that still offers the chance of benefiting from market swings.
Why is DCA perfect for beginners?
If you’re new to crypto, trying to time the market successfully isn’t easy. You’re also probably more likely to suffer from FOMO and be prone to panic buying/selling if you’re new to investing. DCA removes these risks by automating your investment strategy so you can get a good average entry price, without any of the stress of watching the markets!
What’s a real life example of how DCA can help?
Jacob wants to purchase $2,500 worth of Bitcoin on December 28th, 2017. The Bitcoin price looks like it could keep going up, so he spends his $2,500. At the time of purchase, Bitcoin was around $20k per coin, meaning Jacob now owns around 0.12 BTC.
Alternatively, Susan decides she wants to purchase $2,500 worth of Bitcoin around the same time, but through the simple and effecting strategy of Dollar-cost-averaging. Using the ‘recurring buys’ feature on the Digital Surge app, she automates to invest $250 dollars into Bitcoin every month, meaning her total sum will be spent in just under a year.
2018 sees a lot of price fluctuation for Bitcoin and 10 months later, after making 10 investments of $250, Jane finds that she owns around 0.22 Bitcoin. That’s almost twice as much as Jacob, and she never had to check the market or take into account the ‘timing’ of her entry. The DCA strategy will not always work out exactly as planned. But it does more often than not, so it remains a useful investing strategy.
What are the potential drawbacks of Dollar-cost-averaging?
Missing out on gains – The no. 1 downside of DCA is the possibility that you might miss out on a large gain you would have gotten if you invested in a lump sum while the market was down. However, timing the market and investing in a lump sum is risky and not an easy thing to do well. Despite this drawback, DCA works well for most people.
DCA is not risk free – When it comes to any investment strategy, there are always risks. For instance, you might start your DCA strategy after a steep rise only to see the market crash a few months later, leaving you worse off than when you started. While this situation does occur, DCA includes buying assets regardless of the price point. Over a longer horizon, this lowers your overall risk and is usually better than lump sum investing.
When does DCA perform best?
DCA works well when markets experience big swings. This is because the strategy is designed to mitigate the effects of high volatility.
How do I use DCA in a bear market?
Let’s say crypto just entered a bear market, and we don’t expect a bull market to come back for at least a few years. Given the bearish conditions, we might also believe in the long term potential of crypto and want to prepare for the future.
If we are in an extended bear market, we must adjust our DCA strategy accordingly. We can’t say for sure how long this bear market will last so we should not make our instalment amount too large.
Say we have $20,000 to invest in total. We could divide that up into 100 chunks of $200. With this amount, the entire strategy will play out over a little less than two years, allowing us to build up a long term position while the market is in a slump.
Note: Many investors would be wary about investing when the market is looking pessimistic. Some may want to wait till the downtrend looks nearly over to start investing. This means they won’t get in at as good a price, but some of the risk of investing during a bear market will be mitigated.
Should I use DCA in a bull market?
DCA pretty much works in all kinds of markets. It’s a low risk, low reward strategy that gets you a good average price, regardless of the market volatility. Bull markets can be unpredictable and highly volatile, so yes, DCA usually works here too.
Does DCA work in a downwards trend?
Yep. If you have a feeling that the price of an asset is about to go down but will recover in the long term, you can use DCA to invest over the period of time when you think a downward movement will happen. If you’re right, and the market goes down, you’ll reap the rewards of picking up that asset at a lower price. And if you’re wrong, you won’t have used ALL your capital up and can continue to invest as prices go up.
If I use DCA, when do I sell?
If you have dollar-cost-averaged into a position, you might want to consider you’re plan to exit your position (cash out). While an exit plan will depend on the individual, a good first step is to determine at what price you would like to start taking profits.
Next, divide up your investment into chunks and start selling them once the asset reaches your target price. This way, you can greatly lessen the risk of not getting out at the right time, while not selling your whole stack in one go should the price continue to go up.
Many people in crypto adopt a buy & hold strategy, where they do not intend to sell for an indefinite period as they believe in the long term potential of a coin. While you should have a general goal in mind for each of your investments, you don’t have to DCA out of a position if you used DCA to enter one.
What is time diversification?
DCA can also be referred to as time diversification. Like regular portfolio diversification, DCA minimises your risk, exposing you to prices across time. This averages out any dramatic increase or decrease in the market while allowing you to benefit from price movements in both directions. For a guide on how to diversify your crypto portfolio, click here.
What is the Bitcoin DCA calculator?
Want to find out how DCA performs over time? You can find a handy dollar-cost-averaging calculator for Bitcoin on dcabtc.com. Enter the amount, the time horizon, the intervals and this calculator will spit out exactly how you would have done if you had used DCA. This can help guide how you might want to approach DCA going forward.
Did this answer your question?
Digital Surge is the easiest way for Australians to buy, sell & store over 250+ cryptocurrencies. With extremely low fees, a uniquely user-friendly interface and a customer-support team you can rely on, getting involved in crypto has never been easier. Sign up today and enjoy safe, stress-free trading.
Crypto-curious? The time you spend here will be the best investment you ever make.
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- ACN 620 473 109
- © 2021 Copyright Digital Surge
