What is dollar cost averaging? A passive approach to investing

Attention patient traders: Dollar cost averaging can be a worthy long-term investment strategy

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Sometimes slow and steady wins the investing race – Photo: Shutterstock
                                

Contents

Dollar cost averaging: A brief history

In his classic book The Intelligent Investor, written 73 years ago and reprinted multiple times since, the British-born American economist Benjamin Graham described dollar cost averaging as a breed of “formula investing” in which “the practitioner invests in common stocks the same number of dollars each month or each quarter. In this way, he is likely to end up with a satisfactory overall price for all his holdings.”

Graham was fond of the dollar cost average approach, supported by a 23-year study by Lucile Tomlinson, which concluded, in 1953: “No one has yet discovered any other formula for investing which can be used with so much confidence of ultimate success, regardless of what may happen to security prices, as Dollar Cost Averaging.”

Of course, these studies were conducted on traditional securities more than 70 years ago, but in recent times, DCA has found favour among passive investors in the volatile cryptocurrency markets, thanks to the comparatively low-risk nature of the strategy.

How do I use dollar cost averaging?

Dollar cost averaging (DCA) is not a complex concept. DCA encourages periodic investments (usually weekly or monthly) of the same amount, regardless of the value of the underlying asset, rather than putting an entire stake down in one lump sum. In other words, invest $100 every month for 12 months in your chosen stock, rather than $1,200 from the start. The secret is that as the stock you are buying moves up and down in price over the year, some months you will be able to buy more of your target stock for your $100, sometimes less. But the average price you pay per share, Graham and Tomlinson found, is very likely to be less than you would pay out, say, buying a fixed number of shares every month, and it is a much easier strategy to manage than trying to buy shares only when their price is low, or appears to be low.

According to Dan Hoover of the California-based digital currency investment firm Castle Funds, “given the volatility of most digital assets, we believe that building a position in your desired asset over time is a good way to reduce the timing risk associated with lump-sum investing.”

Dollar cost averaging requires a degree of self discipline. Some exchanges do have recurring-buy options, but they are not universal. Platforms such as Mudrex can also implement an automated DCA schedule, though costs may be involved. Elsewise, investors either rely on a good memory, or set phone alerts as a reminder to place a trade.

In the crypto world, dollar cost averaging is also referred to as “stacking sats” (sats being short for satoshis, the smallest divisible unit of a bitcoin, 0.00000001 BTC).

Dollar cost averaging versus lump sum investing

Dollar cost averaging is not a perfect strategy: according to Hoover, “In traditional stock-and-bond markets, with historically lower volatility, DCA is often shown to be less effective than lump-sum investments.” 

But in the unpredictable crypto markets, DCA can reduce timing risks, while also reducing the emotional drive to exit a lump-sum position should the market move against you.

In the opinion of Simon Furlong, co-founder of the UK-based staking protocol Geode Finance: “By investing in small increments over a longer period of time, you can avoid making emotion-driven investment decisions, and better manage extreme market volatility by not deploying all of your capital at one time and price point.”

However, Furlong does concede that “generally, people who DCA into bitcoin have underperformed those who made well-timed lump purchases.”

How profitable is dollar cost averaging?

The nifty calculator at dcabtc.com shows us what we could have earned by using dollar cost averaging on bitcoin (BTC) over the years. $6,000 invested in BTC over five years in $100 monthly increments (dating back from 10 May) would have netted us $32,421 for a 440% return on investment (ROI) (minus exchange fees, of course).

In comparison, had we thrown $6,000 in $500 monthly increments for the past year, at 10 May 2022 we would have been down down -4.71% on our investment.

What if we had invested that $6,000 in $55 monthly increments over the past nine years? We d be 6,587% up on our investment and extremely satisfied, despite BTC having lost almost a third of its value in the past month alone (as of 10 May).

Though not an exact science, these numbers do not lie. Dollar cost averaging can be a wise long-term strategy and a hedge against volatility. However, nobody knows where bitcoin is going next, let alone the altcoin market. Crypto’s unpredictable behaviour throughout 2022 has certainly driven that point home. Therefore, investors should not assume profits will begin flowing in just through implementing a DCA strategy. But is it wiser than aping into the latest shitcoin or meme NFT? Probably.

Please note that the above article does not constitute financial advice. Any investment strategy is a personal decision and should be implemented following genuine independent advice from an expert. Never invest with more than you can avoid to lose.

FAQs

What is dollar cost averaging?

Dollar cost averaging (DCA) is a long-term trading strategy involving periodic investments (usually weekly or monthly) rather than a lump sum, regardless of the price of the underlying asset. DCA is beneficial for volatile markets such as cryptocurrency.

How do you use dollar cost averaging?

Some exchanges have recurring-buy options, though dollar cost averaging often requires keeping to a predefined schedule and making regular payments into your trading portfolio.

What are the benefits of dollar cost averaging?

Dollar cost averaging can be lower risk compared to momentum trading, and less prone to the emotionally driven exits often seen in lump-sum investments.

Further reading

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