April 01, 2020 |James Messi
Dollar-Cost Averaging (DCA) is a sound investment strategy, which has been utilized across all major asset types. The express purpose of using DCA as an investment tool is to increase an investors allocation size into an asset, while minimizing the impact of short term price fluctuations. These price fluctuations are known as “volatility” which is the measurement of how much an asset’s price increases or decreases in a set timeframe.
Let’s strip down the DCA concept with a simple example:
John is going to purchase $994 dollars worth of Bitcoin with the goal of getting the best overall price-point. There are two methods that John can use when buying Bitcoin. The first, buying the $994 worth of Bitcoin in a lump-sum purchase, and the second is using DCA over a 3 month period.
Let’s follow John’s results using both methods below and then review the results together after:
Lump-sum purchase ($994.00 purchase on one buy)*
Date of Purchase: November 10, 2019
BTC Price at the time of purchase: $8,977.02
Approximate Amount of BTC purchased: 0.11072717
Approximate USD value of investment today (February 10, 2020): $1,087.61
DCA ($994.00 purchase using DCA over a 3 month timeframe starting on November 10, 2019)*
Date of initial purchase: November 10, 2019
Frequency of purchases: Weekly
Number of total purchases: 14
Size of each purchase: $71.00
Approximate Amount of BTC purchased: 0.12346878
Approximate USD value of investment today (February 10, 2020): $1,212.77
Average BTC price per purchase: $8,050.62
*Price data and DCA results sourced from https://www.costavg.com/
The results clearly demonstrate that John ended up with a higher amount of profit while using Dollar-Cost averaging. This is because through DCA John minimized the adverse effect price volatility can have on his total investment performance. It is important to note that as an asset Bitcoin sees higher levels of price fluctuations compared to more mature legacy investment vehicles such as equities, securities and commodities. In fact, not only did John mitigate against the risks that volatility can bring, but instead actually capitalized on the price movements of Bitcoin.
Pro tip: In the cryptocurrency market some exchanges offer recurring purchases as a feature. Utilizing this feature will automate your purchases while employing DCA. A best practice when choosing an exchange to conduct your business on is conducting your own research. While finding exchanges that offer appealing features is important, what’s more imperative are the reliability and fees structures of the trading platform. Exchanges are for-profit businesses so please make sure to pay attention to the amount they are charging customers per purchase. Here is just one site that can help compare the various exchanges and their fees https://www.finder.com/cryptocurrency-exchange-fees.
In our study above DCA outperformed the Lump-sum purchase over a 3 month period, but this is not always the case. Markets tend to trend up over a long time period, and the higher levels of volatility in the cryptocurrency markets do present prime buying opportunities for advanced investors. However, timing financial markets for the best buy-in is a risky and extremely challenging proposition.
In summary, DCA is a tried and true investment strategy particularly for beginner and even intermediate investors. The power of DCA comes from its ability to cut down on an investors risk, by minimizing the effects of short term price fluctuations. Using an exchange that offers recurring purchases as a feature, is a smart way to automate your DCA strategy for the most efficient method of execution.