Dollar cost averaging refers to the practice of investing fixed amounts at regular intervals (for instance, $20 every week). This is a strategy used by investors that wish to reduce the influence of volatility over their investment and, therefore, reduce their risk exposure.
The term “dollar cost averaging” was coined because such a strategy opens the potential for reducing the average cost of the total amount of assets purchased. As a result, the investor could be buying less of an asset while the price is relatively high, and more units of that asset as the price goes lower. In other words, the investor would enter in a position gradually, instead of doing it on a single move.
Let’s look at an example of dollar cost averaging:
On the first of January, Alice and Bob decide they wish to invest in Bitcoin. However, they have different profiles and distinct investment strategies.
On the one hand, Bob wishes to purchase $500 of BTC each week until he accumulates one entire bitcoin.
|USING DCA STRATEGY|
|BTC Purchased||Total BTC (sum)||Total Cost|
January 01, 2018
January 08, 2018
January 15, 2018
April 23, 2018
April 30, 2018
May 07, 2018
Bob managed to accumulate one BTC for a total price of $9500 over time, by investing $500 each week regardless of the price volatility.
Alice, on the other hand, decided to purchase one whole Bitcoin at once.
|NOT USING DCA STRATEGY|
|Total BTC||Total Cost|
January 1, 2018
Alice acquired one BTC on the 1st of January, with a total investment cost of $13,400. Such an example illustrates how the DCA strategy may be useful. In this case, Alice has paid significantly more than Bob, by purchasing one BTC all at once, and she didn’t have any other opportunity to buy lower because she decided to enter the market in a single move.