What is Dollar Cost Averaging (DCA) and why is it a powerful strategy?
Let’s say you want to start investing in a cryptocurrency like the big almighty Bitcoin, or the magical Ethereum, or if we’re scrubbing the bottom of the barrel even Dogecoin. So you check the price of whatever coin you’re looking at and you see that it’s at an all-time high. You expand the graph to see the one-year trading graph, and you see that if you would have invested $600 you would have made $10,000 in profit.
But like usual, you still don’t invest and you figure you might wait for the next low, especially since you’ve already gotten the dopamine high of thinking how rich you could have been.
A few weeks later you check it and you say “Oh no, the price is super low right now! Maybe the project isn’t going anywhere.” Well, a few more weeks of this passed, the decision fatigue kicks in and you don’t purchase any of the coins at all.
When it comes to the mathematically smartest way to invest in a project that you believe in the long term, the solution is simple: you should average out your investment and do something that is called dollar-cost averaging.
Definition
This simply means instead of waiting for the perfect moment to buy a lump sum of crypto, you would put in certain amounts at regular intervals. DCA is a form of investing that has worked well for ages, and we can apply it to pass data from things like the stock market to see that it mathematically works out well.
Instead of stacking your money in your mattress and trying to time the market for Ethereum to hit a new all-time low to which you can hopefully time it and then sell at a peak, you invest a little bit over a long period. This way you are buying in at both the highs and the lows.
Protection against high and low points
Now, in terms of DCA, the period can be days, weeks, or even months. For example, let’s say you wanted to get into Bitcoin. Instead of looking at the price and letting your emotions make your decisions, you agree to yourself that you’ll put in $200 each month.
Of course, some months would be higher and some would be lower, but beating your emotions is exactly what the DCA method is trying to achieve. You’re averaging out your investments so that over time you are buying into the stock or crypto but aren’t affected by super high points or super low points as much as if you just invested a lump sum.
My experience with DCA
Moving on, I want to share some anecdotal experiences. About this time almost 2 years ago, my dad, my brother, and I began putting in $40 a month each divided equally into 4 different cryptocurrencies that we thought were interesting. It didn’t matter if the project was going well or if it was going bad, I still put in my $40 and so did the rest of the members of my family.
Later, our portfolios performed very well, at least when you compare them to the stock market. It’s not because we were some great investors predicting the next big boom, but it’s because we stuck to our plan of investing in certain projects that we believed in, and they did well over time.
Another time that I have dollar cost averaged was a few years ago. I began putting $500 into my Roth Ira as a form of retirement. Being self-employed I knew that I had to start early since it’s really easy to go every month without committing. Well, $1,000 a month works perfectly now, as the yearly limit of the contributions is $6,000.
But now my portfolio has grown to more than $30,000 just by investing in a simple index fund. All of this is done automatically on the first of every month. Looking back, it would have taken a lot of willpower to simply save that much, and quite a bit of that is profit from price appreciation and dividend returns.
According to Forbes
An article on Forbes stated that investing lump sums during any dip has been proven to maximize your investment if the investment is up. However, DCA has been proven to avoid major losses.
Another big benefit of DCA is that you can set it up to happen automatically each month. And this is important so that the psychological barrier to investing is non-existent each month. If we compare these two graphs below of S&P 500, they use the two strategies of either buying the dip, or DCA.
Buying the dip wins, but it doesn’t win by much. For me, I don’t think that this improvement is worth watching the price every day to see if there’s a dip. If we’re being technical about it, you could probably spend this time working on a hobby that you enjoy or even spending extra hours at your job to give you more money to invest.
Always have a plan
Either way, the smartest way to invest is to have a plan. Many investors rely on their emotions at the time that they either buy or sell. But in reality, the best investors have plans. Maybe something like buying any dip that’s more than 10% with the money that they have saved up, or something like spending $40 a month on a coin, no matter what the price is.
How do you get started?
Now, we need a drum roll! The million-dollar question is: how do you get started? Well, it’s as simple as figuring out how much you can allow yourself to invest in whatever you want to invest in. For me and my family, $40 was easy each month because it was just extra cash.
Commitment
Something else I would recommend is also to start a spreadsheet to track what you have invested. Now once you start investing, it’s time to commit. This is the hardest part, and if you haven’t read my blog post on diamond hands versus paper hands this would be a great time to check it out because you’ll be tempted with a lot of different emotions once you start gaining money in your accounts.
Auto DCA
I also want to say that many large central exchanges have programs that allow you to dollar cost average. For example, Coinbase and Binance, both have options to do something like invest weekly, so that they will spend a certain amount each time that you’ve set up.
Another thing to think about is the fees paid using these options. For example, Coinbase’s fee usually drops off after you spend at least $200. Under that, the fee can eat up quite a bit of your investment, so do your own research on them to see if it’s worth it for you.
Conclusion
Now that I’ve told you about DCA, I need you to take a little bit of action. Whether it’s $5 a day, $20 a week, or $1,000 a month, if you believe in a coin and you want to invest, I recommend putting something in and letting it sit. Emotions and investing do not mix.
If you have any other questions about DCA, please stop by the KogeFarm Telegram or Discord communities, where you’ll always find someone willing to help you out.
