Cryptocurrencies such as Bitcoin undergo price volatility daily. Volatility in the crypto market is one of the biggest drawbacks of this type of investment. This makes it more uncertain, with a fear of missing out and a fear of participation.
Here the important question is what will be the best price to invest while prices fluctuate?
Well, ideally, it’s quite simple, apply the formula of BUY LOW, SELL HIGH!
In reality, this is a little more challenging to implement. Rather than trying to “time the market,” most investors use a DCA (dollar-cost averaging) strategy to reduce the impact of market volatility, thereby investing a small amount into an asset such as stocks, crypto, or gold on a regular schedule.
DCA seems the right choice, particularly when someone believes their investment amount would be increased in the long run and they experience price fluctuations on the way there.
What is DCA (Dollar-Cost Averaging) ?
DCA is a long-term strategy in which an investor usually buys smaller amounts of an asset over time, no matter the price. For instance, invest $100 in Bitcoin monthly for a year instead of $1,200 at a time. Their DCA schedule ranges from time to time, depending on the goals. It can last a few months or many years.
DCA is a famous way to buy BTC, but it is similar to crypto. Traditional investors and expert traders have used this technique for years to weather stock market volatility. You may even use DCA if you invest in your employer’s retirement plan every payday.
Benefits of DCA
DCA can be an efficient method to own crypto without the difficult work of timing the market or the risk of unwittingly spending all of your funds for investing “a lump sum” at a peak.
The main key is selecting an affordable amount and investing on daily basis, no matter the price of an asset. This can “average” out the cost of purchases with time and decrease the overall effect of a sudden price decline on any given investment.
And if prices decline, DCA investors could continue to buy, as scheduled, with the potential of earning returns as prices go to recovery.
When is DCA more effective than lump-sum investing?
DCA can enable the investor to safely enter a market, take advantage of long-term price appreciation, and averages the risk of downward price movements in the short term. And in these situations, like the ones below, it may give you more predictable returns rather than investing a lot of cash at a time:
- To Buy an asset that may increase in value over time
Suppose an investor thinks prices are about to rise but are likely to recover in the long term. In that case, They can use DCA for investing cash over the period they consider a downward movement tends to happen.
If they’re right, they will get benefit from picking up assets at a very low price. However, even if they’re wrong, they would have investments in the market as the price goes uphill.
- Hedging bets via volatility
DCA is basically a rule-based approach to investing. Beginner traders often fall into “emotional trading,” where buying and selling decisions are dictated by various emotional and psychological factors such as excitement or fear. This may push investors to manage their portfolios ineffectively.
How does DCA work in practice?
Obviously, the success of the DCA strategy is still subject to market conditions. Let’s see an example using real-world prices right as they have approached Bitcoin’s biggest downturn.
If you invested $100 in BTC every week starting in December, you would have invested a total of $16,300. But on January 25,21, your portfolio would be worth around $65,000, which is a return on investment and more than 299%.
Contrarily, going “all in” as prices increase is considered a bad idea. Still, the question is, How could you know this?
If you had taken that amount of $16,300 and invested it all on Dec 18, 2017, you would have lost around $8000 within the initial 2 years. Though your portfolio recovers, you would have lost out on the ability to compound your profits in the meantime.
BTC Dollar-cost average Vs. Lump sum
Let’s say you waited for 12 months and invested $200 in BTC every month between Dec 2018 and Dec 2020.
In this case, your portfolio would be more than $13,000 in 2020, compared to $23,000 from investing a wholesome amount. This “all-in” investment will help you earn a great profit. However, it would also have been a risky process that any significant price movements after your first investment date would have affected your entire investment.
Portfolio value over time
| Dollar-cost averaging (Total invested) | Dollar-cost averaging (Estimated total portfolio) | Lump sum investment (Total invested) | Lump sum investment (Estimated total portfolio) | |
| Dec 1, 2018 | $100 | $100 | $5,000 | $5,000 |
| Dec 1, 2019 | $2,600 | $3,267 | $5,000 | $8,844 |
| Dec 1, 2020 | $5,000 | $13,240 | $5,000 | $23,462 |
Total return from Dollar cost averaging: 165%
Total return from Lump Sum investment: 369%
Wrapping Up
Dollar-cost averaging is all about hedging your bets: it hinders your potential upside from mitigating possible losses. To serve as a potentially safer choice for investors, it decreases your chances of taking serious hits to one’s portfolio caused by short-term price volatility.
To know if DCA is the right method, it’s important to consider your unique investment circumstances. It’s always best to consult a financial professional before understanding a new investment strategy.
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