Whether you’re looking to part with $100 or $100,000, there’s always the fear that following an initial investment, the market will go down and you lose money. On the other hand, the idea of missing a rally is equally as daunting and often leaves investors overeager to invest quickly.
Fortunately, there’s a third strategy that sits nicely between the two options.
What is dollar cost averaging?
Dollar cost averaging (DCA) is the process of investing your money over time. Instead of investing in one single lump sum and trying to time the market to your advantage, you divide your initial investment into several tranches and trade at a set time periodically.
For example, an individual with $100,000 to invest may decide to:
- Invest $25,000 per quarter for four quarters.
- Invest $8,333 per month for 12 months.
- Invest $3,846 every two weeks for 26 weeks.
- Invest $1,923 per week for 52 weeks.
The idea behind this method is that by purchasing smaller amounts over a period of time as opposed to in one go, you’re more likely to average out with a better return.
Most people tend to set strict schedules and specific times when placing DCA trades. For example, Bob might decide to split his $10,000 into 100 tranches of $100 and use each tranche to purchase bitcoin (BTC) every Monday at exactly 12:00 ET, regardless of what the bitcoin market price is at each interval. He hopes that after he’s spent his entire $10,000 amount, he will end up with more BTC than if he went all-in on a single trade.
Platforms that provide automated dollar cost averaging
Modern investment platforms and trading software, such as Coinbase, 3Commas and Cryptohopper, are built to facilitate dollar cost averaging. The user will link their bank account to their investment account or deposit an initial amount and manually set up the scheduled contributions.
The investment platforms are able to automate the investments; beyond the initial setup, there is very little work for the investor to do.
From an emotional perspective, leveraging automated investment systems like dollar cost averaging helps remove the stress associated with timing the market – something that regularly plagues novice crypto traders.
To demonstrate the efficacy of a simple DCA strategy, we can look at how investing small amounts in bitcoin over a 10, five and one year period would’ve worked out.
To set up our scenario, we will assume an investor has been investing $1 per week into bitcoin every Monday at 12:00 UTC, using data from www.dcabtc.com.
Principal invested: $520
Total amount: $371,034
% change: 71,252%
Principal invested: $260
Total amount: $2,015
% change: 675%
Principal invested: $52
Total amount: $62
% change: 19.2%
When you look at these numbers, it’s hard to not wish for a time machine in order to go back to the early days of Bitcoin. But the point is, even what may seem like a small amount of money, can turn into a significant amount of money over time. Investing $52 per year for five years turns into over $2,000! If you can do $52 per week or more, the final number grows even larger.
Read More: Is There a "Best" Time to Trade Crypto?
Dollar cost averaging and 401(k)s
Dollar cost averaging is a strategy that has been utilized by millions of people in 401(k) accounts. According to Fidelity Investments, the balances in 401(k) accounts hit an all-time high in 2021. 401(k) accounts have unique rules and because of these rules, almost everyone who utilizes a 401(k) as an investment vehicle deploys some sort of DCA strategy.
When an investor uses DCA as their wealth-building strategy, the accounts build up slowly at the beginning and after enough time, there are significant assets in the account.
Dollar cost averaging is appealing to anyone not trying to time the market. It decreases volatility, removes the need for discipline and is uniquely appealing to investors with a limited amount of money to invest upfront.