What Is Dollar-Cost Averaging?
5 mins read
5 mths ago
What Is Dollar-Cost Averaging?
Investors use so many investments in the crypto and the US stock market, and the dollar cost averaging strategy is also one of them.
It is usually hard for a beginner to understand some of the strategies used in the financial markets, which is normal. A good explanation of the dollar cost averaging strategy will help you know how it works, what is involved, and how to use it.
Continue reading as we explore what dollar cost averaging is, the advantages, and illustrations of how to use the strategy.
Dollar-cost Averaging Definition
Dollar-cost averaging is an investment and effective trading strategy that involves investing equal amounts of funds into the financial market from time to time, irrespective of the market situation.
In simple terms, an investor who uses this strategy will be investing an equal amount of money at regular intervals into the financial market, whether the market is good or bad.
This dollar cost averaging definition means that the intervals for these investments can be weekly, monthly, or yearly depending on what the investor wants.
One reason people favor this investment strategy is that it reduces the risk of losing all your funds due to putting your capital into the financial market at once. Dollar-cost averaging helps to spread the risk of loss and the impact of a loss over some time.
How Dollar Cost Averaging Works
Dollar Cost Averaging
To understand "what is dollar cost averaging", I will use hypothetical illustrations to understand the whole concept better.
Let's say you are a crypto investor and want to invest a total of $500 on bitcoin in the crypto market; dollar cost averaging is one of the best strategies to apply.
Within that $500, this investment strategy mandates that you will not put all the funds into the crypto market in one go; instead, it is at regular intervals.
Let's say you choose to invest the money every month; then, you will have to divide the money according to the months it can last. For $500, you can decide to put $100 into the crypto market every month by buying Bitcoin. This means that for 5 months, you will put in $100 every month whether the price of bitcoin is high or low.
For instance, if bitcoin’s price was at $20,000 when you first put in the first $100, you will still have to put in another $100 in another month even if the price of bitcoin goes down to $15,000 or goes up to $30,000.
Advantages of Dollar Cost Averaging
With the example of dollar cost averaging given above, here are some of the benefits that come with making use of the discussed investment strategy.
Elimination of Emotional Factors:
One of the problems faced by many newbies and even some experienced crypto investors is that they sometimes allow their emotions to get a better part of them which isn't advisable while making investments.
With the example of dollar cost averaging above, this investment strategy forces the crypto investor to make investments whether the market is bullish or bearish. As shown above, this means that whether the price of bitcoin is low or it is high, you will still be able to put some money into the market.
Spreading Of Risks:
Some of the disasters that happened to investors in the crypto market were when they put in all their funds at once, and a bearish season brought many losses.
Hypothetically, a dollar cost averaging investment strategy helps you to spread the risk of losing a big amount of money which is usually the best option. Moreover, with this strategy, one will have time to choose the best time in the market within each week, month, or year to make their investments.
Yes, with the dollar cost averaging investment strategy, a crypto investor can build up a portfolio worth a lot of money within a period instead of waiting for the perfect time. It is a profitable crypto trading strategy.
Let's say the goal of a crypto investor is to invest up to $100,000 in the crypto market, and they don't have that amount of money at that time. Using the dollar cost averaging investment strategy, they can quickly start putting in $10k per month until they reach their goal of $100,000 within ten months.
Disadvantages Of Dollar Cost Averaging
Higher Trading Fees
In the crypto market, you have to pay a transaction fee for any transaction you make, and the higher the transaction, the higher the gas fees.
An investor who invests $500 once into the crypto market may pay less gas fee than an investor that makes transactions of $100 every month for 5 months.
Market Opportunities Passed Up
The market tends to rise over time, which is a disadvantage of dollar-cost averaging. This means that investing a lump sum sooner is likely to outperform investing smaller amounts over time. Because of the market's rising tendency, the lump sum will provide a better long-term return.
Should I Use Dollar Cost Averaging?
Good investors in the crypto market know that there is a need to apply different investment strategies to have other options at any time.
The explanation above answers the question of "what is dollar cost averaging", which is one of the common investment strategies investors need to learn.
While this investment strategy helps to spread the risk of loss, eliminate the emotional factor, and help build capacity, one may have to pay more gas fees while using its principles.
Disclaimer: This article is meant to provide general guidance and understanding of cryptocurrency and the Blockchain network. It’s not an exhaustive list and should not be taken as financial advice. Yellow Card Academy is not responsible for your investment decisions.