What Is Dollar Cost Averaging (DCA)?
Table of Contents
- Dollar-Cost Averaging is an investment strategy for long-term value investing, not short-term gains.
- Dollar-Cost Averaging is a good approach for inexperienced or passive investors.
- Dollar-cost averaging in Bitcoin can generate high growth for investors.
What is Dollar-Cost Averaging?
Dollar-cost averaging, also known as the constant dollar plan, is an investment strategy wherein an investor divides their planned total investment amount into periodic payments. These payments are usually made monthly or weekly, and can be automated with select investment partners. An investor will choose a dollar-cost averaging strategy in an effort to reach their total investment goal while mitigating the risk associated with the volatility of the asset price. Dollar-cost averaging is a value investing strategy most beneficial for an investor seeking long-term value from their investment.
This strategy is used in 401(k) plans because the money is invested on regular intervals based on paychecks. Doll-Cost averaging makes sense under the assumption that the chosen asset will increase in value long-term, but will experience volatility along the way.
What are the Benefits of Dollar-Cost Averaging?
There are many benefits to dollar-cost averaging that make it an attractive investment strategy for investors:
Automation. Purchase can be scheduled for set time intervals throughyour River investment account, allowing your investment to grow with relatively little oversight.
Lower Risk. Dollar-cost averaging allows investors to mitigate risk by buying at many different prices as the price of the asset fluctuates between their recurring purchases. In this way, dollar-cost averaging can lower an investor’s exposure to volatility and keep their average cost basis closer to the current price of the asset.Without dollar-cost averaging an investor runs the risk of buying a large quantity of an asset near a local price maximum.
Passivity and Simplicity. Because dollar-cost averaging is a long-term investment strategy that isn’t based on purchasing at specific price points, it requires less attention, expertise, and analysis from an investor. Combine these qualities with automation, and it’s possible to achieve long-term asset growth without having to commit much oversight to your investment.
To illustrate the outcome of dollar-cost averaging into Bitcoin, let us examine a historical example. An investor wants to invest $12,000 in Bitcoin over a 12-month period, beginning in October 2018. One year later, the investor’s original $12,000 investment, invested at a rate of $1,000 per month, would be worth $21,742.26.
Despite the volatility of Bitcoin’s price during this period of time, dollar-cost averaging allowed the investor to manage the risk and achieve long-term growth of their investment. Alternatively, if the investor had invested all $12,000.00 upfront it would only be worth $15,143.56 one year later.
Dollar-cost averaging removes emotions from trading. Many investors attempting to time the market will sell when a price is low out of panic or buy when a price is high due to fear of missing out. Trying to time the market often harms investors long-term returns. Dollar-cost averaging eliminates the need to time the market.
What are the Drawbacks of Dollar-Cost Averaging?
Dollar-cost averaging is known for being a straightforward, lower-risk long-term investment strategy. However, it’s not the right investment strategy for every investor. Depending on your investment goals, there are some facets of dollar-cost averaging worth considering before investing:
Mild Returns. Dollar-cost averaging can successfully circumvent an asset’s volatility, but in doing so it misses out on ultra-high returns in favor of more normative return rates. If an investor is seeking a high investment return, dollar-cost averaging may not be the best strategy.
Higher Fees. When dollar-cost averaging, the investment made in each period is much lower than a lump-sum investment. As such, fees might be higher when buying in smaller amounts. If an investor is investing with a financial institution that charges higher relative fees for smaller amounts, or is generally weary of paying fees, there may be more efficient investment strategies for them.
Capital Inefficiency. Properly deployed capital is expected to increase in value over time. For this reason money today is always better than money tomorrow. However, dollar-cost averaging delays the time to capital deployment, negating the value of having money which could have been invested earlier.
Why DCA Bitcoin?
Dollar-cost averaging is a widely-used investment strategy across many asset classes, as well as Bitcoin. Dollar-cost averaging is well suited for Bitcoin because Bitcoin is a volatile asset. It’s small market cap means the market can be moved by relatively small purchases. Dollar-cost averaging into Bitcoin allows inexperienced traders to participate in the growth opportunities of Bitcoin without being overwhelmed by price fluctuations and the intensive market analysis needed in alternative investment strategies. In addition, the projected long-term growth of Bitcoin is substantive, and dollar-cost averaging can position investors to realize these long-term gains for themselves while minimizing short-term volatility.