How many times have you been recommended to buy low and sell high? Seems pretty simple. Most markets will go through cycles where the price of the asset either is increasing or decreasing over a period of time. But how do you time the market to make a return? This can be way easier said than done, even for financial experts. One strategy that may help you reduce your risk is Dollar Cost Averaging.
As an investor, the last thing you want to do is invest a lump sum of cash into an asset at a time that happens to be its peak. Dollar Cost Averaging (DCA) is an investment strategy, generally long term, that takes advantage of market downturns and reduces your risk compared to lump sum investing. With DCA, the investor will invest a total sum of money in small increments over a period of time, no matter what the price of the asset is at. DCA is designed to reduce the risk that you get with short-term market volatility and still be able to invest in assets that you truly believe will be big in the future. The goal is to take advantage of market downturns without risking too much capital at once.
While DCA investors may purchase shares of an asset when the price is high, they will also be purchasing it when the price is low, therefore lowering the risk, but also lowering the reward. Investors may not always purchase the asset at its lowest possible price, but a DCA strategy removes much of the perplexing work that goes into attempting to time a market.
With crypto historically being a considerably volatile asset class, the DCA investment strategy has become very dominant among crypto investors. Committing to such a strategy means that regardless of how the market is doing, the average price you pay for your crypto, should even out over time if you believe the asset class will appreciate long term. The following are two examples of dollar cost averaging with Bitcoin.
Example 1: If you invested $100 in Bitcoin every week starting in December 2017, which was that year’s peak price, until January 2021, you would have invested a total of $16,300. But by the end of January 2021, your portfolio would be worth approximately $65,000. That comes out to be a return on investment of 299%, as shown below.
Example 2: If you dollar-cost-averaged into Bitcoin by purchasing $5 a week in 2020, you would have gained $692 from a $275 total investment, providing a 160% return. Although this may not have yielded the highest profit, it protects you against the possibility of investing at Bitcoin’s price peak.
If you want a relatively safe way of benefiting from crypto’s volatility, a DCA strategy is worth considering.
Like any other investment strategy, DCA has a couple drawbacks that you must take into consideration before using the technique.
The first main drawback is the small fee you need to pay when making a transaction, which means if you are using the DCA strategy, you will incur more trading costs compared to investing a lump sum. Because DCA is a long-term strategy, these fees should become relatively small when looking at your gains years in the future. Be sure to keep track of the trading fees you are paying to get an accurate calculation of your profit.
Another drawback from not investing the lump sum of your budget is the potential gains you will miss out on if your chosen crypto goes into a stage of consistent increase. With crypto being generally volatile, it is not likely for something like this to happen very often unless there are major changes or news in the industry.
Regardless, this is a circumstance that you have to be willing to miss out on when choosing a low-risk investment strategy like this. On the other hand, if your chosen crypto goes into a stage of consistent decrease, your losses are extremely less, and you will end up taking a larger profit when the price goes back up.
The last drawback is that your DCA investment schedule may force you to buy after a steep rise in the price of your chosen crypto, which leads to facing a downward correction afterwards. A perfectly conducted DCA strategy includes following your schedule at any stage, whether it be stable, decreasing, or increasing. If done consistently, a DCA strategy will lower your risk and potentially lead to larger profits in the distant future.
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Step 1: Decide which cryptocurrency you would like to invest in and deposit the money you are prepared to invest into your Bitbuy account.
Step 2: Instead of investing the lump sum into your chosen cryptocurrency, plan out your investment to be incrementally invested at a stable rate. You can choose to do this weekly, bi-weekly or monthly but make sure that the amount you invest stays consistent.
The key to committing to a DCA strategy is choosing an amount that’s affordable for yourself and investing a consistent amount at regular intervals, no matter the price of the crypto. This has the potential to average out the cost of purchases over time and reduce the overall impact of a sudden drop in prices on any given purchase. You must stick to your purchase schedule and overlook the doubt, greed or fear associated with short-term investment strategies.
Happy Dollar Cost Averaging!