Learn how the dollar-cost averaging strategy works, why it can help manage risk in volatile markets, and the key steps to consider when investing in crypto.
Cryptocurrencies like Bitcoin are known for their extreme price volatility. A digital coin that is soaring to new highs one week can be in a sharp downturn the next. This makes the decision of when to buy particularly stressful. Investing a large sum of money at the wrong time could lead to immediate and significant losses. This is where a time-tested investment strategy called dollar-cost averaging, or DCA, can be a powerful tool for managing both risk and emotion.
1. What is dollar-cost averaging?
Dollar-cost averaging is an investment strategy where you divide up the total amount of money you want to invest and purchase the target asset at regular intervals, regardless of its price. Instead of investing $1,200 all at once, for example, you would invest $100 every month for a year. The core idea is to buy consistently over time, which helps to smooth out the average price you pay for the asset.
This is a disciplined and systematic approach to investing. It takes the difficult and often emotional decision of “when is the right time to buy?” completely out of the equation. Your only decision is to stick to your pre-determined schedule of regular, periodic investments, which makes the process much simpler to execute.
2. How DCA helps to manage price volatility.
The primary benefit of dollar-cost averaging is that it helps to mitigate the impact of volatility on your investment. When you invest a fixed dollar amount on a regular schedule, you automatically buy more shares (or a larger fraction of a coin) when the price is low, and fewer shares when the price is high. This can result in a lower average cost per share over time compared to what you might have paid if you had invested all your money at a market peak.
This is especially useful for volatile assets like Bitcoin. By spreading your purchases out over time, you reduce the risk of investing all your money right before a major price drop. This averaging effect can lead to a less stressful investment experience.
3. The difference between DCA and lump-sum investing.
The main alternative to dollar-cost averaging is lump-sum investing, which involves investing all of your available capital at once. Historically, for less volatile assets like broad stock market index funds, studies have shown that lump-sum investing has often produced higher returns, simply because the market tends to go up over time and you have more money working for you for longer. However, this approach also comes with higher risk.
For highly volatile assets like cryptocurrency, the risk of a poorly timed lump-sum investment is much greater. Dollar-cost averaging, on the other hand, is a risk-management strategy. You may potentially sacrifice some upside if the price only goes up, but you gain significant protection against the downside of a sharp market decline.
4. Why DCA is a great tool for removing emotion from investing.
Two of the most powerful and destructive emotions in investing are fear and greed. Greed can tempt you to invest all your money at a market peak out of a fear of missing out (FOMO). Fear can cause you to panic-sell during a downturn or to be too scared to invest at all. Dollar-cost averaging is a powerful antidote to these emotional traps because it automates the decision-making process.
By committing to a regular, automated investment schedule, you are forced to be disciplined. You will automatically buy when prices are falling and others are fearful, and you will buy in smaller, measured amounts when prices are soaring and others are greedy. This removes your emotions from the equation and helps you stick to a rational plan.
5. Step one is to determine your total investment amount.
Before you begin a dollar-cost averaging strategy, the first and most important step is to decide on a total amount of money you are willing to invest in a speculative asset like cryptocurrency. A widely accepted rule of thumb is to never invest more than you are willing to lose. You should determine an amount that, if it went to zero, would not have a catastrophic impact on your overall financial well-being.
Once you have this total figure in mind, you can then decide on the timeframe over which you want to invest it. For example, you might decide you are comfortable investing a total of $2,400 over the course of a year.
6. Step two is to set a consistent schedule and amount.
Once you have your total investment amount and your timeframe, the next step is to break it down into a consistent schedule. Using the example of $2,400 over one year, you could choose to invest $200 once a month. Alternatively, you could break it down even further and invest $50 every week. The specific frequency is less important than your commitment to consistency.
The key is to choose a schedule and an amount that you can comfortably stick to, regardless of what the market is doing. This pre-commitment is the core of the DCA strategy, as it forces you to continue buying even when the market is down, which is often the most opportune time.
7. Step three is to automate your purchases whenever possible.
The most effective way to ensure you stick to your dollar-cost averaging plan is to automate it. Most major cryptocurrency exchanges and brokerage apps, including Robinhood, Coinbase, and others, allow you to set up recurring buys. You can schedule a specific dollar amount to be automatically invested in the cryptocurrency of your choice on a daily, weekly, or monthly basis.
Automating your purchases ensures that you will not forget to invest or be tempted to skip a purchase because of fear or uncertainty. It takes the discipline out of your hands and puts it into the hands of a simple, automated rule, making it one of the easiest investment strategies to implement.
8. A common mistake is to stop the plan when the price drops.
The most difficult part of dollar-cost averaging, psychologically, is continuing to buy when the market is in a steep downturn. When the price of your asset is falling, your natural instinct might be to pause your purchases to “wait until the bottom.” However, this defeats the entire purpose of the strategy. The moments when prices are low are precisely when your fixed dollar investment is buying you the most of an asset.
To get the full benefit of the “averaging down” effect, you must have the discipline to stick with your plan through the market’s downturns. A practical tip is to avoid checking your portfolio too frequently during these periods and to simply trust in the long-term, automated process you have set up.
9. A key consideration is that DCA does not guarantee a profit.
It is crucial to understand that dollar-cost averaging is a risk-management tool, not a magic bullet that guarantees you will make money. If the asset you are investing in goes down in value and never recovers, a DCA strategy will still result in a loss. The strategy can help you get a better average price, but it cannot protect you from a fundamentally poor investment choice.
Therefore, it is essential that you still do your research and have a long-term conviction in the asset you are choosing to buy. DCA is a strategy for how to buy, not a replacement for the important decision of what to buy.