Dollar-Cost Averaging Strategy Helps Investors Optimize Profits
Rather than timing the market, investors use a strategy called DCA (dollar-cost averaging) to optimize their profits and minimize their risk or a poorly-timed purchase.
Dec. 29 2021, Published 8:16 a.m. ET
Often, there are more investors than there are investment strategies. The most common mishap in investing is attempting to time the market and timing it incorrectly.
Instead of trying to time the market to see when the best time to acquire assets is, investors use a strategy called DCA (dollar-cost averaging) to optimize their profits and minimize their risk. What's dollar-cost averaging and how can investors implement the strategy?
What is dollar-cost averaging?
Dollar-cost averaging is an investment strategy that decreases the impact of volatility on an overall purchase. Through DCA, a user is purchasing a given asset periodically as opposed to seeing when the "timing is right."
For example, if an investor is looking at cryptocurrencies, he would want to invest in and select the currency. Regardless of price, DCA is the practice of systemically investing equal amounts across periodic purchases of a target asset.
How does dollar-cost averaging work?
DCA avoids making the mistake of purchasing one large lump sum of a poorly timed buy regarding the asset price since investments get made regularly. In this way, DCA is a strategy implemented to build savings and wealth over a long period.
A real-world example of DCA is most 401k plans. The equity is purchased regularly in a fixed amount, regardless of the price. Employees pre-determine the amount they want to allocate towards their 401k, which gets deducted from their salary. This percentage is used to invest in mutual funds and indexes every time an employee gets paid.
In crypto, DCA works similarly, but it functions as a decentralized currency and it isn't limited to the parameters of stocks. Users can make daily market purchases at any hour, which is important given the volatile nature of cryptocurrency.
Cryptocurrency platform Coinbase integrates a DCA automation feature for all tokens listed, which allows users to set recurring purchases at their desired frequency.
Price volatility suggests that the token prices drastically increase and decrease, sometimes in a short period. Therefore, DCA improves the overall performance of an asset as long as the investment price increases.
While this doesn't protect the user from declining prices in the market, users need to manage each asset's performance.
What's an example of dollar-cost averaging in crypto?
An investor wants to purchase Cosmos (ATOM) and views it as a viable asset to invest in long-term. The investor decides to invest 10 percent of his salary bi-weekly.
Making $2,500 bi-weekly, the investor purchases $250 worth of Ethereum every two weeks. With two recurring payments of $250, the investor purchases $500 worth o ATOM monthly regardless of price fluctuations.
At this rate, and assuming that ATOM maintains its current price of $26.95, the investor accumulates over 16 ATOM a month. Since cryptocurrency is volatile, this method is one of the more conservative strategies.
While DCA is a fundamental investment strategy, those who actively trade in crypto find that it could be a bit more beneficial to "buy the dip" to reap much quicker profits.
However, many investors find that time in the market is much better than timing the market.
Dollar-cost averaging is a conservative strategy to build savings and wealth over a long period without having to find the perfect time to buy.
