Lump-Sum Investing vs. Dollar-Cost Averaging
This research was sponsored by Luno, a platform that allows users to buy, save and manage cryptocurrencies.
If you have been in to bitcoin and crypto investing for more then a few years, or even a few months, you probably have heard of dollar-cost averaging, or “DCA.”
What does it mean? Investopedia describes it as follows:
“Dollar-cost averaging (DCA) is an investment strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset in an effort to reduce the impact of volatility on the overall purchase. The purchases occur regardless of the asset’s price and at regular intervals.”
Instead of trying to time the market, which is notoriously difficult to do, DCA involves making consistent, regular purchases. A person could, for example, buy a fixed amount of an asset every week or month.
The opposite of this would be lump-sum investing. This is exactly what it sounds like, as it involves an individual investing a large amount at a single point in time.
What are the advantages and disadvantages of these investment strategies?
Let’s start out by evaluating the pros and cons of lump-sum investing. The biggest advantage is putting your money to work right away.
The largest disadvantage is that since this approach involves making a single investment, the results can be impacted significantly by market conditions, specifically volatility. There are several reasons why crypto markets are so volatile.
One is that these particular markets are still young, only a decade old, and they are therefore still in their infancy.
Further, they have fewer participants than the traditional markets, and less capital is involved. This can make the crypto markets vulnerable to manipulation by “whales” or investors who make large trades. Speculation can also add to the volatility.
Big market makers use algorithmic software programs to trade, which can also help worsen the fluctuations of digital asset values.
Past that, the crypto markets are truly “free markets.” They are open 24 hours a day, 365 days a year, and buyers and sellers are always making transactions.
Because of this sharp volatility, anyone who makes a lump-sum investment is at risk of suffering a substantial loss if the markets head lower.
It is important to keep in mind that nobody knows for certain what will happen. Even if an investor’s theory is supported by significant data, it could potentially fail due to a shift in market conditions, something that can happen very quickly.
There are always going to be unforeseen circumstances. For example, the global oil markets have frequently drawn the interest of investors, and when armed conflict broke out in Ukraine, oil prices skyrocketed. Before this situation developed in early 2022, market participants likely would not have seen this coming.
On the other hand, we have dollar-cost averaging, where the investments are made consistently and at regular intervals. What are some advantages to this approach? The biggest benefit of this technique is that it makes it easier to manage volatility. Since the investments are spread out, the cost of purchasing the asset is “averaged” out over time.
Further, DCA does not require an investor to have a large sum of money like lump-sum investing does. If you are looking to gradually make investments over time, DCA may be the strategy for you.
The biggest disadvantage is that if an investor deploys their capital one step at a time, they can’t put all their available money to work right away. There is a wide body of evidence that time in the market is crucial, so there is something to be said for investing one’s money sooner rather than later.
One study, published by Northwestern Mutual in 2021, found that lump-sum investing produced more compelling returns than DCA. More specifically, the team that performed the research looked at two scenarios, one that involved putting a single $1 million into the U.S. markets, and another that made monthly investments over the course of 12 months.
They then evaluated the rolling, 10-year returns of these investments.
The team members who did the research looked at several potential portfolios, including one that contained 60% equities and 40% bonds, another composed completely of equities and a third made up entirely of fixed-income securities.
In all the aforementioned potential portfolios, investing a single sum and holding it for 10 years outperformed DCA roughly 75% of the time.
By focusing on allocations involving stocks and bonds, the Northwestern Mutual study does not account for new markets that have emerged over the last decade, for example the crypto markets, and the significant volatility they can experience on a regular basis.
These sharp fluctuations can potentially deter risk-averse investors, and this situation can make it difficult for newcomers to get involved in the crypto markets.
By leveraging DCA, one can harness a different approach that uses consistent, disciplined investing to achieve long-term goals.
I wasn’t able to find many studies quantifying how DCA was more effective than lump-sum investing, but I did encounter some evidence illustrating the usefulness of this approach.
Crypto analyst Wicked Smart Bitcoin conducted some proprietary research that evaluated the results of using DCA and then holding bitcoin for varying time frames. It found that after a certain amount of time had lapsed, HODLers were all in the green.
“No one has ever been in the red after daily DCAing #bitcoin for at least 3 years,” it stated. “Chances are you’ll be in the green much sooner than that!”
Michael Saylor, chairman and CEO of Microstrategy and prominent bitcoin bull, also tweeted this exact same information from Wicked Smart Bitcoin.
Conclusion
Like I stated earlier, the main reason I find dollar-cost averaging easier is because it eliminates the risks associated with attempting to time the market. By using this approach, investors can avoid falling victim to common pitfalls, for example panic selling when their assets are falling in value or purchasing more simply because those assets are appreciating.
DCA is completely different, as it involves investors making regular purchases at scheduled intervals, regardless of what an asset’s price is at the time.
Again, consistency and discipline are key to achieving one’s financial goals.
I always tell people when they ask that dollar-cost averaging is the “Jedi master” trick for investing in bitcoin.
Dollar-cost averaging takes time to understand, and seeing its benefits may require months or years of implementation. Once you are familiar with this technique, you realize that if you do not have a large amount of capital up front, you can create a plan of making regular investments and stick to it.
It’s just like anything else you set out to do in life: take the first step, keep up the hard work, and the results will come with time!
This content is for educational purposes only. It does not constitute trading advice. Past performance does not indicate future results. Do not invest more than you can afford to lose. The author of this article may hold assets mentioned in the piece.
If you found this content engaging, and have an interest in commissioning content of your own, check out Quantum Economics’ Analysis on Demand service.
