Once you understand “Dollar Cost Averaging” or DCA, you’ll never forget it.
You wake up in the morning looking at your $12,000 of savings and believe that they’re not being utilized. Then, you embark on the idea of investing in them. You could invest them in the stock market or cryptocurrency, but that’s beyond this article.
Let’s say you decided to invest them in the stock market. Let’s say we’re in the year 1929 (I know that’s a long time ago, but it will make this easier to explain.)
It’s the beginning of September of 1929, and you just buy various stocks that you believe are good. (For example, from the S&P500.)
Congratulations, you bought it at an average price of $31.30. Now you feel relieved; if the market behaves as it did in the past 50 years, then you’ll make a good profit.
You leave those $12,000 for an astonishing ten years. You promised yourself you wouldn’t look or monitor your investment progress.
The day arrives; you open up your account, and your balance is…. $7223.
You withdraw and decide to never invest or listen to that friend who advised you to do so again.
Now what happened in the situation above is that you simply put all your savings on the price of $31.30, which apparently was too high during the year. But how could you have known? You can’t really predict tomorrow’s price.
The thing about the stock market is that it always fluctuates. There’s always a low price and a high price. Yes, you can’t know which time is the cheapest and which time is the most expensive. (Analysts try, but they’re never 100% certain.)
So then, how about instead of spending the whole $12,000 in September with the price of $31.30, you would invest $100 each month for ten years. This way, you will be buying at the worst times and at the best times in equal amounts. That’s dollar-cost averaging.
Once you grasp the numbers aspect of DCA, you would logically see that DCA is the least risky way of investing in the stock or the crypto market.
Will this guarantee you the best results?
Obviously not, because some people would be lucky enough to place all their investments at the lowest price and sell them at the highest price. However, there is no certain way to know whether a stock will keep declining or inclining.
However, let’s say you used DCA in the above example with your $12,000 of savings in the year 1929. If you had invested $100 per month for ten years, then you would end up with…. $15,571, which is around a 25% profit.
What you’re doing with DCA is you’re telling the stock market. If you incline, I will make half the maximum profit, and if you decline, I will lose half the maximum loss. Then, given the stock market’s impressive performance every five years or so, you’ll be in the profit zone.
This is particularly healthy with cryptocurrency investment as well, as the market is very unpredictable, and almost no one can point out to the bottom of a dip that’s occurring.
Here’s a fantastic image from Binance explaining DCA.
Should I always use DCA?
Here, I have to note that what’s said here in this article is not financial advice; it’s only a definition of what a strategy is. Dollar-cost averaging, according to top investors like Benjamin Graham, is very healthy to maintain over the long term. However, investment geniuses like Warren Buffet don’t necessarily do that. His analysis skills (and probably a huge team), along with studying the financials of a company, would give him an estimate of where the stock price is on the curve. Hence, he is more likely to pick stocks that would increase over the upcoming ten years or so.
However, most of the people are not Warren Buffet. Hence, it’s a safe and sound strategy that is very wise to consider.
Does this mean I will always make half of the best performances?
Well, technically speaking, if a person with your exact portfolio was able to predict when the lowest price was and bought, then. Only to sell at the peak stocks performance, then she/he would be making around double what you’re making. (Which is referred to as lump-sum investing)
This all depends on whether you’re a defensive investor or not. It depends on what you’re looking for in your investments and the level of risk you would like to have.
Finally, it’s not only about DCA vs. the lump-sum investment. There’s another variable that you’re in charge of that could make a bigger difference than deciding on those strategies. That is your portfolio choice. This is something you’re in control of and could actually do some extensive studying to improve your odds of success.
At the end of the day, your savings are yours to invest.
Hence, you should do your study and testing in order to be able to know what works for you. You might be a person who spots dips very well. In that case, a lump sum strategy might be extremely profitable. However, if you’re not that person and you’re rather conservative, then test out the DCA strategy and figure out what’s best for you.
Note: This is not financial advice, merely stating a definition of a couple of investment strategies. If you’d like a furthermore extensive read, I would advise you to read “The Intelligent Investor by Benjamin Graham.”