What is Dollar-Cost Averaging? All You Need to Know
Are you struggling with capital allocation to your crypto portfolio? Are you done with dedicating effort and time to researching the portfolio management tips? If yes, then we have an amazing way to make all your troubles disappear and make investing extremely easy for you. Dollar-cost averaging is your one-stop solution to combat market volatility, manage your portfolio, and ensure long-term steady returns over a long period of time. In this article, we will discuss all the basics you need to understand about this approach and ways to implement it.
What does Dollar-Cost Averaging Mean?
Dollar-cost averaging is the process of breaking the total amount of money that you want to invest in a target asset among several periodic purchases. This is done in order to reduce the effects of factors like price volatility on the overall purchase of the asset.
Using this strategy eliminates the additional burden of timing the market and finding the best moments to buy an asset. It is because the investors purchase the asset for a fixed amount of money regardless of the price of the asset at that time.
In addition to being an effective way to neutralize market volatility, it is also a perfect way to build investments in a particular asset over a long period of time. However, the challenge for investors here is that they have to choose an asset that is sure to increase in value over time.
Some investors even argue that dollar-cost averaging is a better investment strategy when compared to “buying the dip”. It is somewhat true as investors have to keep a keen eye on the prices to find the dips. On the other hand, if you are investing a fixed amount of money at regular intervals, there are more chances of buying assets at dipping prices rather than looking out for them intentionally.
How does Dollar-Cost Averaging Work?
Dollar-cost averaging is a very simple approach that requires the least amount of work. The entire process can be summed up in five simple steps.
- Select the assets that you want to buy.
- Select the amount of money that you want to invest in that asset.
- Choose the duration of your periodic investments like weekly, monthly, etc.
- Break the total amount of money to be invested in the number of periods of investments. You can use any online dollar-cost averaging calculator for this step.
- Buy the asset for a small part of the money at regular intervals.
Isn’t it too easy? This is exactly why most salaried professionals implement dollar-cost averaging as their go-to investment strategy without the involvement of any extra stress or pressure to correctly time the market or buy the dips.
Is Dollar-Cost Averaging a Good Idea?
Yes, Dollar-cost averaging can be a good idea since it provides a range of benefits of the user. Some of these benefits are discussed below.
Reduces investment risk
Ths investment approach is an excellent way to reduce the market risks such as buying the asset in lump sum especially when the prices of the assets are high due to buying pressure in the market. As a result, the dollar-cost averaging strategy helps the investor to escape the risk of buying a smaller quantity of assets than needed. It provides liquidity to the investor and boosts long-term portfolio growth.
The cost of investment is low
The strategy allows the investor to buy assets when the prices are going down. This creates an opportunity for the investor to buy more shares at a lower price. Hence, the cost of investment is lower than usual.
Helps to manage the emotional investments
Some investors buy assets according to the turn of their emotions. In instances like impulse buying, dollar-cost averaging eliminates the risks associated with it as the investor is bound to invest a fixed amount of money irrespective of whether the market is a bull market or a bear market. It also prevents the investor from buying assets based on the market hypes or news around specific assets.
Eliminates the bad market timing
There is no denying the fact that it is impossible to time the market perfectly. Even the most polished investors can not master the art of timing the market correctly. Therefore, dollar-cost averaging appears as the best strategy to prevent the risks of bad market timing affecting your overall portfolio performance.
Can You Lose Money with Dollar-Cost Averaging?
Well, we can not say that you can lose money with dollar-cost averaging. However, there are certain risks and disadvantages involved in implementing this strategy. For example, if the transaction costs are higher than the profits you are making, it may look like you are losing money with this process. Similarly, here we are discussing some other cons of using dollar-cost averaging in your investment journey.
Asset allocation is tricky
As mentioned above, dollar-cost averaging requires investors to allocate investment capital to a particular asset only, to manage the various investment risks. In case an investor ends up choosing the wrong assets, the investor may face increased risks of investments. Also, since market sentiments change over time and assets increasing in value may change, the investor’s inability to realign their investment goals with asset opportunities may cause risks.
Returns may be low
All of us are aware of the proportionality that exists between investment risks and investment returns. Since the dollar-cost averaging investment approach significantly reduces the risks of investment, it is obvious that the returns are also low. It is because the investors can invest in assets only at fixed intervals of time and not on the basis of market sentiments.
Implementation can be difficult
Sometimes, the effort needed to monitor the performance of the assets in dollar-cost averaging may be too high. Also, in case of wrong asset allotment, the investor may not have any choice but to continue with the investment or drop out of it with losses. Therefore, dollar-cost averaging poses a difficulty for asset monitoring and realignment of investment goals.
In the case of a crypto market that keeps flooding with the effects of price volatility, dollar-cost averaging can be a miracle approach, especially for new crypto investors to eliminate risks and maintain the gains over a long time. The best part is that you can use the strategy with minimal knowledge and effort, especially if you have a limited amount of funds to invest. So, start investing in dollar cost-averaging crypto now!