What is Dollar-Cost-Averaging?
Definition: Dollar-cost averaging (DCA) is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases at regular intervals, regardless of the asset’s price.
How does Dollar-Cost Averaging work?
Dollar-cost averaging is an investment strategy that involves investing equal amounts in an asset, at regular intervals, regardless of its price.
The idea is that by utilizing DCA, the investment may not be as subject to market volatility (rapid price changes) in comparison to investing a lump sum all at once.
How does that work?
Imagine that today is December 1, 2017 and you want to invest $ 1200 in Bitcoin.
You saw that Bitcoin was booming and decided to spend your entire $1200 at about $10 000 per BTC, ending up with about 0.12 BTC.
Now, let’s say you decided to use DCA and invest $100 each month, over a 1 year period, so you simply buy $100 worth of BTC at whatever the price is on the first day of each month.
Your trades would look something like this:
- December 1, 2017 – BUY 0.01 BTC @ $10 000 per BTC.
- January 1, 2018 – BUY 0.00714 BTC @ $14 000 per BTC.
- February 1, 2018 – BUY 0.01 BTC @ $10 000 per BTC
- March 1, 2018 – BUY 0.01 BTC @ $10 000 per BTC
- April 1, 2018 – BUY 0.0142 BTC @ $7000 per BTC
- May 1, 2018 – BUY 0.0111 BTC @ $9000 per BTC
- June 1, 2018 – BUY 0.0133 BTC @ $7500 per BTC
- July 1, 2018 – BUY 0.0166 BTC @ $6000 per BTC
- August 1, 2018 – BUY 0.0125 BTC @ $8000 per BTC
- September 1, 2018 – BUY 0.0142 BTC @ $7000 per BTC
- October 1, 2018 – BUY 0.0142 BTC @ $7000 per BTC
- November 1, 2018 – BUY 0.0166 BTC @ $6000 per BTC
In total, you’d end up with about 0.15 BTC at an average price of about $8458.3 per BTC, or about 50% more BTC.
Why use Dollar-Cost Averaging?
Using the DCA strategy reduces the negative impact that a bad entry may have on your investment.
Let’s go back to the example above, and say you perfectly timed the market and bought at the yearly low price for 2018 of about $3200. You’d have a hefty 0.3125 BTC, which is more than double the amount you’d get via dollar-cost averaging. Why not just do that?
The answer is rather simple – because you can’t predict the markets.
Nobody can, which is why DCA has its place and why it’s considered a very good investment strategy.
Dollar-Cost Averaging has another benefit, which is that you don’t have to worry about tracking the market movements all the time – you simply buy for the same amount, at the same interval, completely disregarding the price.
So is DCA the perfect investment strategy?
Unfortunately, no.
Dollar-cost averaging works in your favor only if the asset rises in value over the long term. DCA cannot protect you against the risk of declining market prices overall, since you will simply keep buying lower and lower and continue losing money.
Using this strategy on an individual asset without knowing anything about its fundamentals and hoping that it will appreciate eventually is a recipe for losing your savings.
Remember, never invest more than you can afford to lose.
Some key questions about Dollar-Cost Averaging.
What is DCA?
DCA is an acronym for Dollar-Cost Averaging.
What is Dollar-Cost Averaging, in short?
Dollar-Cost Averaging is an investment strategy, focused on investing equal amounts of capital in an asset, at regular intervals, regardless of the current market price.
How does DCA work?
DCA works by reducing your exposure to market volatility by investing at a smoother average price.
Why use DCA?
Using Dollar-Cost Averaging, instead of investing a lump sum can protect you from buying an asset at an all-time high price.
When not to use Dollar-Cost Averaging?
DCA can not protect you from a long-term market decline. It’s important to always research the fundamentals of any asset that you plan to invest in.
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