Dollar Cost Averaging for Dummies

What is Dollar Cost Averaging?

The concept of Dollar Cost Averaging (DCA) may not be new to you as it has been a common technique used by investors over many years and may be something you’ve been partaking in none the wiser.

When someone is looking to invest in something typically they will do some due dilligence and find an asset they believe is worthy of their hard earned money. In terms of Cryptocurrency, say an investor wants to invest in Bitcoin. They’ve done their research and they believe in the technology… Great! But I’m sure you’ve heard of horror stories, particularly the most recent LUNA crash that sent many investors broke. Everyone knows investing in Cryptocurrencies can be extremely risky, if you invest all your money today, it can be gone tomorrow. So, how do we avoid losing all our money?

Let me introduce you to Dollar Cost Averaging - it’s really simple.

Instead of investing all of your funds in one purchase, the DCA framework requires an investor to disperse their funds evenly across a series of purchases over a long period of time.

Let’s say you want to buy Bitcoin at its current price of ~$20,000.

For instance, if you have $10,000 to invest, you might want to (instead of investing all $10,000 at once) split your funds up into $50-500 increments and buy a smaller piece of a Bitcoin on a daily, weekly, monthly or even yearly basis. It’s up to you how much and how often but the concept remains the same.

Why is it important?

The reason DCA is so important to investing properly is due to volatility in markets. We’ve seen Bitcoin fluctuate thousands of dollars in a single day, a double-edged sword which can burn you very easily. We’re not here to gamble though, remember? At any moment your investment could become essentially worthless, but with this method you are reducing your risk greatly.

Let’s take a look at the math! (Using hypothetical prices of course)

You first purchase $500 of Bitcoin at $20,000, you own 0.0250 of a Bitcoin at a cost of $500.

A week later you purchase another $500 of Bitcoin although the price of Bitcoin is now at $21,000. You now own 0.0488 of a Bitcoin at a cost of $1000.Another week goes by and the market has taken a dive - you purchase another $500 of Bitcoin at the price of $16,000. You now own 0.08 of a bitcoin at a cost of $1500.

With these three purchases your average purchase price is $19,000, which although not great considering the current price is (theoretically) $16,000 - it’s still a hell of a lot better than it being $21,000.

Say the price shoots back up to $21,000 the next week, you must still invest another $500 but you’re now a lot further in the green than if you had dumped it all in at the start. This process must continue over a series of months to be effective and means that you do not have to try and time the market to find the top or bottom. The goal is always to reduce your average purchase price and accumulate over a large period of time to avoid being greatly affected by any volatile moves.

Is DCA right for me?

I’m not a financial advisor and this certainly isn’t financial advice but DCA certainly isn’t suitable for everyone. It depends greatly on the length of your investment horizon, how much you have to invest and how accepting of risk you may be. For instance, if you only have $100 to invest it might be best to invest it all in one lump sum or simply not invest at all.

It is always best to consult a licensed financial advisor before making any investment decisions and they should be able to give you some clarity on whether this strategy may be right for you. DCA takes a lot of the emotional side of investing out of the picture although it does require a lot of discipline in order to be effective.

What are the downsides?

You may miss some profitable moves, but that’s okay! You aren’t trying to scalp trade here - you’re looking to invest over a long period of time and avoid major dips. You may also find that you lose a little bit more money on fees than if you purchase it all in one parcel, but we’re talking pennies here, and we aren’t interested in pennies.