So what is dollar cost averaging? Dollar cost averaging (DCA) is an investment strategy that consists of purchasing a fixed amount of an asset on a regular basis, e.g: every week, fortnight or month. This strategy contrasts with lump-sum investing (which consists of buying a lump sum of an asset and holding onto it). For example, if you had $10,000 to invest, a DCA strategy might involve purchasing $200 worth of your chosen asset every week for 50 weeks rather than investing $10,000 in the first week.
“By following a simple practice known as dollar cost averaging, you can protect yourself against market fluctuations and downside risk in the market. By buying a fixed dollar amount on a regular schedule, your focus is on accumulating assets on a regular basis, instead of trying to time the market.”
Why use dollar cost averaging?
Dollar cost averaging minimizes the downside risk associated with purchasing a lump sum of an asset right before the price drops. Some other benefits of dollar cost averaging include:
- Forces the investor to purchase fewer units at a higher price and more units at a lower price.
- Reduces the emotional burden of investing and trying to time the markets.
- Allows the investor to build a diversified portfolio over time whilst maintaining cash reserves in case unexpected things happen.
- For people with a regular income, it makes investing more predictable, and easier to stash money away before spending it.
For investors that are less averse to risk, and have a longer-term view on investing, DCA provides a great way to build a market position over time. In volatile markets such as the burgeoning cryptocurrency space, this strategy can be a valuable way to get the best of both worlds – building a position whilst not needing to worry about the short-term ups and downs of the market.
Gabriel has $1,000 to invest in bitcoin and decides to purchase $100 each week over 10 weeks.
|Week||Bitcoin price||Lump sum purchase||Dollar cost averaging|
|1||$13,000||$1,000/$13,000 = 0.076923||$100/$13,000 = 0.0076923|
|2||$12,500||–||$100/$12,500 = 0.008|
|3||$12,000||–||$100/$12,000 = 0.008333|
|4||$13,000||–||$100/$13,000 = 0.0076923|
|5||$14,000||–||$100/$14,000 = 0.0071428|
|6||$11,500||–||$100/$11,500 = 0.0086957|
|7||$10,000||–||$100/$10,000 = 0.01|
|8||$11,000||–||$100/11,000 = 0.0090909|
|9||$12,000||–||$100/$12,000 = 0.008333|
|10||$12,500||–||$100/$12,500 = 0.008|
|Total:||$12,500 end price||0.076923BTC = $961.54||0.0823045 = $1,028.81|
In this hypothetical example, Gabriel would have been better off using the dollar cost averaging method of purchasing bitcoin. This example does not take into account network fees, exchange rate fluctuations, exchange commissions and other costs.
If timed right, purchasing lump sums of cryptocurrencies can be prosperous. However, purchasing a large number of digital assets can easily lead to market-related anxiety due to the extreme volatility of this young industry. It is natural to want to purchase more when the market is rising rapidly and less when the market is declining. However, this is counter-intuitive and can lead to suboptimal gains. As we can see in the example above, the dollar cost averaging strategy leads to investors taking the opposite approach: purchasing more bitcoin when the price is lower, and less when the price is higher.
The risks of lump sum investing
When buying cryptocurrencies such as bitcoin from exchanges, there are a number of risks and downsides that can be mitigated through using DCA:
- The fees charged to an individual investor for transferring money, converting between currencies, commissions and network fees can add up very fast, especially when purchasing sums under $10,000.
- When purchasing cryptocurrency through an exchange, it can be easy to forget to withdraw your assets from the exchange to private wallets. Although the exchange provides convenience for buying and selling digital assets, if the exchange is hacked or shut down, there is a very real risk of losing your money.
- Exchange fees decrease based on trade volume. The average investor buying cryptocurrency from an exchange will be paying the highest rate on exchange fees.
- Due to the explosive market growth of cryptocurrencies, combined with government anti-money laundering/know your customer (AML/KYC) regulations, it has become a difficult and timely process to get set up to purchase bitcoin from the main, most liquid exchanges.
How to avoid the risks of lump sum investing
Cryptosaver solves these issues by collecting small investment amounts ($10-$200) from individual investors and pooling them into one large purchase, then distributing the cryptocurrencies to each investor’s respective wallet on a weekly basis. We have commercial accounts set up with major exchanges and are able to pass the savings from purchasing in bulk on to our customers.
For investors, it is easy to get set up with Cryptosaver: