Dollar-cost averaging is an investing strategy that’s designed to protect your portfolio from market volatility (price swings). It works like this: Rather than making a single large purchase all at once, you instead make several smaller purchases over time.
Volatility in a market refers to the amount of ups and downs in the prices of things like stocks, bonds, or cryptoassets. When there's a lot of volatility, prices can change rapidly and unpredictably. When there's low volatility, prices are more stable and don't change as much.
Different factors can cause volatility, such as news, economic events, or how people feel about the market. Volatility is important because it affects how much money people can make or lose when they invest.
Cryptocurrencies are generally considered more volatile than many other traditional asset classes, such as stocks, bonds, or commodities. Two of the main reasons for the higher volatility in cryptocurrencies are:
The benefits of dollar-cost averaging are:
While dollar-cost averaging offers several benefits, there are some disadvantages to consider:
The most common dollar-cost averaging strategies are passive interval-based buying strategies, for example buying daily, weekly, or monthly. There are more advanced strategies that introduce rules-based or actively managed elements. For example, adding a rule to a monthly strategy that stipulates purchases above the 34-day Exponential Moving Average (EMA), a technical indicator, should be reduced by 50%. As you can see, even adding one rule can make dollar-cost average strategies much more difficult.
Choosing the “optimal" interval, or adding rules on top of simple dollar-cost averaging strategies can eek out a couple percentage points, but for most people, using a simple interval-based strategy with a frequency of once a month is the best. There are several reasons for this:
Most people are already busy enough. Avoid the extra work, high levels of stress, and risk. Invest in crypto smartly with a straightforward dollar-cost average strategy. In the next section we’ll look at how dollar-cost averaging performs in two extremes of the market, “buying the top" and “catching the bottom."
Buying the top
“Buying the top" refers to the act of purchasing an asset at its highest point before it experiences a significant decline in value. While everyone wants to buy low and sell high, the problem is that it can be extremely difficult to know, at any given time, whether you’re in a peak or a trough. Let’s look at a situation where you buy the top:
We start with an initial purchase on January 1, 2018, and consider a two-year time frame. Bitcoin price at purchase: $13,657 Bitcoin price after two years: $7,200 Total investment: $2100
Scenario A: Lump-sum purchase on Jan 1, 2018
Amount of bitcoin purchased: 0.1465 BTC Value of investment after two years: $1,055 Profit/loss: -50%
Scenario B: Dollar-cost average
Purchase amount and frequency: $20/week for 105 weeks starting on Jan 1, 2018 Amount of bitcoin accumulated: 0.32 BTC Value of investment after two years: $2,327 Profit/loss: 11%
Summary
We can see that dollar-cost averaging results in a modest profit rather than a significant loss.
Catching the bottom
"Catching the bottom" refers to the practice of attempting to buy an asset at its lowest possible price during a market downturn or correction. This strategy can be very profitable if executed correctly, but it is also risky because it is difficult to accurately predict when an asset has reached its lowest point. Let’s look at a situation where you manage to catch the bottom:
Here we start with an initial purchase on January 1, 2019, and again consider a two-year time frame. Bitcoin price at purchase: $3,844 Bitcoin price after two years: $29,374 Total investment: $2100
Scenario A: Lump-sum purchase on Jan 1, 2019
Amount of bitcoin purchased: 0.52 BTC Value of investment after two years: $15,274 Profit/loss: 400%
Scenario B: Dollar-cost average
Purchase amount and frequency: $20/week for 105 weeks Amount of bitcoin accumulated: 0.2584 Value of investment after two years: $7,591 Profit/loss: 260%
Summary
We can see that dollar-cost averaging, while resulting in less profit than a lump-sum purchase, nevertheless resulted in significant gains.
The short answer is no. If the asset you’re investing in never increases in value, you simply can’t make money on it. Therefore, you should only engage in a dollar-cost averaging strategy if you believe in the long-term fundamentals of an asset. That being said, for Bitcoin, dollar-cost averaging has always been a winning strategy, as the following chart helps to demonstrate:
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