Dollar-Cost Averaging is a long-term investment strategy used mainly by beginners or passive investors to gradually increase their investments over a long period.
It means that you can invest the same value each month to purchase shares, regardless of the share value, which is likely to fluctuate. You can then split this investment over months or years to divide up the investment equity.
Over a more extended period, these investments will increase your share ownership, and those shares should average out slightly higher than the original cost per share that you started with.
How Dollar-Cost Averaging Works
To make DCA work, you’d need to settle on a price that you’re happy with spending monthly. Say that is $50 from your usual salary. $50, in this example, might buy five shares in your business or other investment assets, making each share $10.
In month two, you’ll invest the same amount of $50; however, because the market has changed, this might only buy you 4.5 shares as the cost per asset has increased to $11.11.
Although you’ve invested the same amount of money, you’ve still increased the value of your assets, even if you’ve bought less this time around. There’s also the chance that next month the shares will be cheaper, meaning you’ll make your money back.
Investing in this way means that you’ll always accrue more shares over time at an affordable price, and the average cost after fluctuation means that you’re likely to make money over time.
This works better than a lump sum payment which, depending on the market, could begin to lose equity as soon as you invest.
The Benefits of Dollar-Cost Averaging
- Steady Investment
You don’t need to have piles of cash to become an investor. Taking the same amount of money out of your salary each month to put towards a scheme will help you maintain your income at a comfortable level while also making you money on the side.
- Beginner’s Investments
It’s an easy and safe way to start investing, and you don’t need any experience to make it successful. It prevents inexperienced investors from making an ill-timed lump sum investment where the asset is at a higher price, which may lose money later.
- Workplace Accessible
If your workplace has a 104 scheme to opt into, you could have the investment funds taken out of your pay and immediately invested into the business with minimum effort on your part. However, this usually means that if the company is sold or changes hands, you’ll be forced to take your shares at the value they’re at on that day.
- Dividing Equity
Because no lump sum is required, it’s an extremely low-risk investment practice. If you continue to watch your shares become more valuable, you can continue growing your investment over the months. However, you’re also able to stop paying into the scheme when it suits you, meaning that if your investment starts to devalue, you haven’t lost a huge wad of cash.
Things to Watch Out for with Dollar-Cost Averaging
- Low Payout
This investment method has no guarantees, but there’s a massive chance that you will make money as the average value of shares will rise over time (though not necessarily rise monthly).
However, you shouldn’t expect a massive return on your investment as the small amounts you’re putting in don’t build up too much over short spaces of time. You’ll make money, but it’s not likely to be millions.
Of course, the more money you invest monthly, the more you’re likely to receive back over time, so your profits will entirely depend on how much you can afford to invest.
- The Long Game
You need to be prepared to play the long game in this sort of investment. Unlike lump sum investments, you won’t have enough to just drop a ton of money in, wait a month for it to increase in value, then pull it out again, doubling your money. It’s not a short-term solution for big lottery wins, but it carries much less risk.
- Missing Out
If you’re able to accept the risk and like the excitement of making a significant return on investment, Dollar-Cost Averaging could make you feel that you’ve missed out. If you pay close attention to the market at the time of purchase and notice your asset is rising in value, it may leave you feeling that you’ve missed out on an opportunity to make more money because you’d decided to play it a little too safe.
Who Invented Dollar-Cost Averaging?
The first related mention of Dollar-Cost Averaging was in a book named The Intelligent Investor by Benjamin Graham in 1949. This book defined the practice as “investing a set dollar amount in the same investment at fixed intervals over time.”
The strategy was originally criticized because the logic of investing in any stock or currency means that you should at least be confident that the asset’s value will increase in the future.
If that’s the case, then investing with a lump sum is bound to make more money, even over the same time period.
However, it’s a favored option for less experienced investors as they gain equity over time too, allowing them a safe option to invest if they aren’t rolling in cash and increasing their owned equity over time.
This is one of the main benefits over lump sum investments as the asset itself doesn’t increase in this instance, so while you’ll make a profit, you’ll still own the same amount of asset.
It entirely depends on the purpose of your investment to decide which option you choose, as, if your intention is always to sell your assets anyway, does it matter too much that your asset ownership doesn’t increase over time?
Does Dollar-Cost Averaging Work with Bitcoin/Crypto?
Dollar-Cost Averaging has been known to be highly profitable when investing in Bitcoin or other cryptocurrencies. Cryptocurrencies naturally fluctuate in value across the global market depending on what they can be used for in different countries and how popular they are.
Recently, cryptocurrencies such as Dogecoin grew in value massively because of the expected changes in the market to use them for broader purchases. Their popularity sparked an increase in investors, which, in turn, increased the value further.
However, the rumors of China pulling out of the Crypto market led to a crash in the market where all coins were again, devalued.
This fluctuation is typical, but Dollar-Cost Averaging means that you can maintain your accumulation of cryptocurrencies over a more extended period, watching for when the market is at its highest before you withdraw.
It’s also possible to leave some of your currency in your account while withdrawing a percentage of your investment if you use a Dollar-Cost Averaging framework, as it means you can get a cash payout and continued accumulation of assets simultaneously.
Other Options for Bitcoin
Another option when looking to invest in Bitcoin or other Cryptocurrencies is value averaging. Because cryptocurrencies can be tracked using apps or a quick Google search, many people are clued up on how the Crypto market is flourishing.
It doesn’t require the knowledge that stocks do when it comes to investments, as anyone can easily monitor the fluctuation value.
For this reason, many people are investing in cryptocurrencies using value averaging.
Value averaging means investing in currency when the market is low, meaning the currency’s value is lower. The currency is then likely to increase in value, and you’d withdraw a percentage once it’s at a peak. High peaks generally come with dips, at which point you’d purchase the currency at the lowest price again, only to increase the value when you withdraw later on.
This is the middle ground between Dollar-Cost Averaging and lump sum investments.
With DCA, you’ll focus on the buildup of the currency asset – meaning you might purchase at the lowest cost sometimes, getting a ton of Bitcoins, but the month after when buying, the value will have increased, meaning you’ll get more Bitcoins, but won’t make as much money on them.
With a lump sum, you’ll buy Bitcoin and wait until it reaches its highest value, then withdraw everything, leaving nothing behind to increase in value and getting that one-time payout.
Does Dollar-Cost Averaging Reduce Risk?
If you’re on a budget, Dollar-Cost Averaging absolutely reduces your long-term risk. Putting smaller amounts into your investment every month will mean that you never accumulate debt due to investing, which is an issue that many first-time, overzealous investors have.
Your accumulation of assets will provide more of a certainty that you’ll make money over a long period, even if the market fluctuates, as the average will likely increase.
Lump sum investments are typically used for a faster turnover or more of an instant cash injection; you’ll most likely get a higher return on investment if the value of your asset increases. However, there’s always the chance that the asset will lose value too, making it a high-risk strategy if you’re looking for an instant reward.
Does Dollar-Cost Averaging Increase Returns?
Yes and no. Dollar-Cost Averaging can increase returns if you’re prepared to wait for the values to build up. However, it’s a very long-term investment, meaning that you’ll be waiting a long time to get those returns back.
Lump sum investments are much more likely to provide high returns as the market fluctuates, as your higher investment will naturally offer more money. However, there is a higher risk here; if the market crashes, it could mean that your investment is lost or returns a lower income than you put in initially.
While Dollar-Cost Averaging will increase your returns, it’s not necessarily the best option for a high payout. However, it is the safer option in that if the market happened to crash, a lump sum investment would lose much more money than an average investment.
What is the Purpose of Dollar-Cost Averaging?
Dollar-Cost Averaging Vs. Lump Sum Investments
Your investment methods entirely depend on your situation and what you want to get out of the investment.
- Is a safe option for a beginner as it only allows spending that you can afford and mitigates the risk of losing money while investing.
- Is a long-term investment and, while it will generally provide a return on investment, it’s not the best option if you need a fast payout.
- Doesn’t require much knowledge of the market where you’ve invested. The process happens automatically depending on the type of investment you make, and the market will fluctuate naturally over months.
- Your asset ownership will grow over time as you purchase more assets each month, depending on the asset value at the time.
- While you will get a return on investment, it’s not likely to be a tremendous amount of money in comparison to a lump sum investment.
Lump Sum Investments
- Aren’t for beginners as they will require you to watch and know the fluctuating markets to ensure you get a high enough return on investment, and equally, don’t pull out your investment too early and miss out on a higher earning.
- They will provide a higher payout than Dollar-Cost Averaging as you’re investing more money. However, the payout is determined by market fluctuation. If the market crashes, your investment will fall, and you may end up having to pull out less than you put in. It’s a risk to achieve a higher payout.
- A lump sum investment can be a quick win if you just need a bit of extra cash. Depending on where you invest, the value of assets can increase quickly, meaning you will get a much faster return on investment if you pull it out at the right time.
- Your asset ownership will remain the same. With a lump sum, you’re essentially putting all of your eggs in one basket, and you won’t end up owning more over time like Dollar-Cost Averaging. If you invest in bad stocks, you’ve lost out.
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