In investment, a strategy is highly needed because we should protect our assets from loss and grow it at the same time to achieve our financial goals. There are so many strategies we can apply, but there is one smart strategy that you might consider, called dollar cost averaging. It is a strategy that will help you to thrive and expand your journey in investment. For further information, continue to read!
What Is Dollar Cost Averaging?
Assume you intend to begin investing in a cryptocurrency such as Bitcoin or Ethereum. Then you check the price of any coin you are interested in and notice that it is at an all-time high. You widen the graph to show the one-year trading graph, and you discover that if you had invested $1000, you would have made $15000 in profit! However, you do not invest and instead wait for the next low. After a few weeks, you check it again and see that the price is really low right now, leading you to believe that it has failed. In the end, you decide not to buy any of the coins because you thought you had lost your momentum, and you failed to start investing.
To tackle that problem, you can try dollar cost averaging (DCA). It is an investment strategy where you buy in small amounts with equal portions regularly, regardless of the price. So, instead of waiting for the perfect moment to buy a lump sum of cryptocurrency at a single price point, you would put smaller equal quantities at frequent intervals. By implementing DCA in your investment activity, you will not let your emotion influence your decision to buy because you will consistently buy in every possible market condition.
For example, say you have $1000 to invest. Instead of investing everything all at once, you can take advantage of $100 every month for ten months, even if the market value changes from time to time during that period. In this way, you are investing at both the highs and lows with fewer purchases in highs and more in lows.
We all know the basic strategy that the best time to invest is when the prices are low. However, it is hard to wait for the perfect timing to buy the asset because the crypto market or even any other market is naturally unpredictable and volatile. Finding the right moment to invest entails extensive knowledge and research into market trends and economic conditions. With this strategy, you will not have a fear of risking your money all at once because you consistently invest it regardless of the price going up and down. DCA is the key to achieving long-term balance with lower risk.
The Difference with Lump-Sum Investing
You might hear of an investing method called lump-sum, which is the polar opposite of DCA. Lump-sum is a method where you put your money all at once into the market. Instead of splitting out your buying over time just like DCA, you would take the entire $1000 and invest it all at once at the most advantageous time frame.
The difference shows in timing because DCA does not need to time the market, unlike lump-sum, which requires market timing since you must invest your money at the ideal moment to maximize profit. In this way, lump-sum can be emotionally challenging as you need to be fully aware because you never know you might invest just before a big market crash.
In using DCA, you will most likely purchase at a variety of price points. When averaged, your price per share may be significantly lower than if you attempted to find the best price and invested all of your money at once. Meanwhile, if you do lump-sum, the price per share is determined by the current market conditions at the time of purchase. Just keep in mind that the differences between DCA and lump-sum show diversity and agility in the investment world.
Risk and Reward
DCA comforts you with its lower risk in investing because, as described before, you do not invest all of your money at one time. When you put your money at once, you will automatically be exposed to a higher risk of the volatility of the market. DCA will help you to spread the investment out over time, reducing the risk and impact of any single market move.
While DCA may be lowering your risk in investing your money, it possibly provides you with comparatively lower returns, especially if market conditions are rising. When you do DCA during the time when the market rises, you may miss out on the opportunity of the possible returns that you could have had if you had invested everything at once. Not only that, your average price will increase as well, which reduces the possible return that you should receive. As a result, in the long term, the profit rate will be lower than the profit rate when you invest all at once.
Assume you invest all of your $1000 at once in a cryptocurrency, and after ten months, the market rises by 15%, which means that your portfolio grows at the same percentage. However, if you only invest it in moderate amounts for ten months, your returns will be smaller since only a part of $1000 is exposed to the overall 15% growth.
In addition, you need to be aware of the brokerage fees you have to pay that can consume your returns because you are making multiple purchases when you do DCA. The fees might be little, but if you make numerous purchases, your fees can feel a little heavy.
Needless to say, dollar cost averaging is much safer for an investor who just entered a crypto market since you split your overall money into equally the same amount every month without having to time the market. Moreover, with this strategy, you can avoid your emotion from influencing the decision since you consistently invest in every market condition. Be sure to choose the right strategy according to your experience, tolerance, and objectives so that your investment will not be a burden for you.