Dollar-Cost Averaging (DCA) is an investment strategy that helps traders balance out the risk in their portfolios. Read more to find out what exactly it entails, how to use it, and how it applies to crypto markets.
It may sound a lot more complicated than it is. But it’s easy to understand DCA if you think of a 401(k) or other type of retirement savings plan. In such a plan, you put a predetermined amount each pay period toward an investment for the many years you are with a company. Sometimes you employer will match your contributions. Either way, there is one set amount that is invested at each time interval. This set amount can be changed (i.e. increased or decreased) but the idea is to have a regular amount invested each week, bi-weekly, or monthly.
So with the IRA or other standard retirement accounts, you have a perfect example of Dollar-Cost Averaging, which is an investor’s tool that involves the following features:
- A predetermined amount to be invested is set.
- That amount goes into the investment vehicle (such as the 401(k)) at regular intervals.
- This arrangement is set for long term investing.
- It doesn’t matter what the price of the assets is in your 401(k) plan from pay period to pay period. The same amount is put towards the investment each time, regardless of that day’s price. Sometimes, you will be able to buy more shares with your $100 contribution. Other times, less.
- You don’t need a lot of money to start investing this way.
The Definition of Dollar-Cost Averaging
Dollar-Cost Averaging is a tool that
Using this method, investors are able to accumulate a position in the market over time. By leveraging regularity and long term planning, they can hedge against market volatility. While some buys will happen when prices are high, typically more buys happen during the lows.
The key is to benefit from long term growth using incremental buys that tend toward a more valuable market position than with day trading and one-time buys. The cost of the shares investors are buying is sometimes high and sometimes low, but the average-cost presents an emotion-free way of consistently buying in a growing market.
As an example of how emotions play into investing, think of popular stocks or cryptocurrencies. When they are running up in price is often the same time investors are “aping” in, buying at high prices because of the Fear of Missing Out (FOMO).
What are the benefits of DCA?
Investors that use this strategy are able to enjoy various potential benefits, including:
- It gives them a way to build their savings.
- They can grow the wealth that they already have.
- This is one way of neutralizing the short term volatility of other investments.
- Regular investment savings is a good habit; it gets you used to
putting away small increments that add up over time.
Dollar-Cost Averaging is not a guarantee of better returns or prices. But it does give the investor more opportunities to buy at different prices, without being beholden to FUD and FOMO.
Traders and retail investors often tend to buy on an upswing when prices are generally higher. By automating the process and spreading it out over time, traders may be able to avoid this type of emotional, reactive buying.
How Does it Work?
If you take a look at the chart below, you’ll see an example of someone contributing the same dollar amount every pay period. You can see the fluctuating share prices of the particular investment (i.e. a stock or a fund), as well as the cumulative number of shares bought.
Dollar-cost averaging is not limited to retirement accounts but it is suited to them quite well. But any pre-determined investment amount that you can set up to recur regularly over a long period of time would be an example of the dollar-cost averaging method.
In the current crypto market, there is considerably more volatility than with traditional markets. For this reason, a case can be made that digital assets are even more suited to dollar-cost averaging than other stocks and funds.
Of course, the more extreme highs and lows also put traders at risk of being influenced by and acting on emotions. All the more reason why a crypto-cost averaging set-up may be a good idea.
Cryptocurrencies are fast becoming a mainstream phenomenon, but compared with stocks and fiat currencies, they are only in their nascent stages. With that said, investors may be exposed to many long term growth and investment opportunities by investing in cryptocurrencies. If you are already investing in crypto or considering it, dollar-cost averaging might be an appropriate investment strategy depending on your financial situation.
It is actually easier to dollar cost average on crypto exchanges and some wallets than it is to set up a traditional retirement or investment accounts. And cheaper. Exchanges like Gemini allow you to DCA virtually any amount of multiple cryptocurrencies, with many different time frames to choose from, including daily!
In addition to the term “Dollar Cost Averaging”, many crypto platforms simply use the phrase, “Recurring Buys”. They mean exactly the same thing.
DCA vs Lump Sum Investing
It’s easy to understand how leaving FOMO out of the equation makes it easier to invest long term. But to really understand how DCA works over the long run, it’s best to use a tool a DCA calculator. This helps you see the potential gains from DCA vs lump sum investing.
The Dollar Cost Average Calculator
To get an idea of how much you could earn through long term DCA with Bitcoin, check out the below calculator. You input the amount you plan to buy each time period and the term. Then you can see the overall performance and even compare it with other assets.
Other calculators are also available for dollar cost averaging other cryptocurrencies. However, with some altcoins and DeFi coins, an early buy approach may be more suitable than DCA. But with these handy calculators, it’s easy for you to DYOR and see how it works in action. Then you can compare your data by looking at the difference between DCA earnings and the long term HODL.
- Just as with dollar-cost averaging of stocks, automation may put traders at a disadvantage in the crypto market. Maybe even more so. That’s because they may become complacent and not pay attention to news that could affect their investments. New technological breakthroughs are announced almost daily with hype and trend trading proliferating easily. It’s important to keep your eyes on any markets that affect your portfolio. There could be a big news story that would make
yourrecurring buy a sub-par investment. If you have some or most of your investing set up as automatic, it’s possible you could be missing out on some opportunities. However, DCA still is a very important part of crypto investing to have working for you. Additional buys and sells are easy over and above DC A. Plus, it’s easy and cheap to do so on crypto’s 24/7 real time markets.
- This method is obviously not great for big, one-time investments or day trading.
- The fees can vary broadly and add up quickly. Over time the fees have lessened for some crypto assets. But often they are higher for crypto’s big guns: Bitcoin and Ethereum.
All in all, crypto-cost averaging is one way to hedge a volatile, emerging market. You gain exposure that builds over time without the stress of reacting to FUD and FOMO. On top of that, each investor may get some level of protection from the crazy ups and downs of the crypto market.
Where Can You Set Up Crypto-Cost Averaging?
Self Directed 401(k)
If you are in the US, self-employed, and have no full-time employees, you may be able to set up what is called a Self Directed Solo 401(k) or even a Roth Solo 401(k), both of which are retirement plans that carry extensive tax benefits.
Unlike the traditional 401(k), investors can open a Solo plan. This allows them to roll over retirement funds into it and essentially become the trustee with “checkbook control”. This means you determine how the fund is spent, including recurring crypto buys. As of this writing, there’s nothing in the US tax code that says you can’t do this.
Popular crypto exchanges like Coinbase, Binance and Gemini all offer easy to set up DCA options for a wide variety of digital assets. In the image below, you can view Gemini’s “Buy Bitcoin” page, which automatically guides into recurring buys. Look for the red arrow where the exchange gives you timeframe options:
Dollar-cost averaging can lower the emotional roller coaster of traditional investments, in particular for crypto assets. Automating decisions and diffusing emotional swings by investing regularly over time can help investors gradually gain a market position. But it’s to their benefit to continue to monitor their investment choices as well and not become complacent. Then they are able to reassess and reallocate to their benefit when the market sees a shift.
DCA is far easier, faster and cheaper to do with crypto assets as opposed to stocks and other investments. This is largely in thanks to decentralized public blockchains and the hundreds of platforms that support them.