When starting to invest, we all have some beliefs about money, wealth, and assets.
Some of those beliefs serve us very well, and others work against our best interests.
Instead of fighting directly against those beliefs, many financial coaches will instead point out a simple rule that makes intuitive sense and helps establish discipline.
That simple rule is Dollar Cost Averaging (DCA).
As a first strategy, it has a number of advantages:
- it’s easy to describe and easy to teach others
- it’s a great long-term buy-and-hold investment tool
- it’s simple to automate
- it’s mathematically sound
- it’s easy to see results, which is always help reinforce the creation of good habits
What is Dollar Cost Averaging?
DCA is easy enough to describe: at a fixed time interval purchase a fixed amount of predetermined assets.
So the three elements are:
- fixed time interval
- fixed amount
- predetermined assets.
A common DCA implementation will often choose a month or quarter as a time interval, but any interval is fine.
How long or short is not as important as developing the discipline to stick to the schedule.
Sometimes the type of asset will dictate the amount to be invested.
While it’s possible to invest virtually any amount into cryptocurrency, other assets will have fixed amounts.
Many mutual funds, for example, enforce minimum amounts.
The last requirement for DCA to work is choosing an asset class.
Some examples of DCA at opposite ends of the spectrum include:
- purchase $5 of Steem every week
- purchase a $250,000 rental property every quarter
Expecting Volatility
So, if the mechanism is simple and the strategy can be applied to many kinds of assets, the real question is: does it work?
DCA works because of the observation that markets fluctuate.
Markets go up.
And then they go down.
And then they go up.
And then they down.
And on and on!
Some strategies try to help figure out the low times of the market to purchase.
DCA takes a more fatalistic approach and just buys the same amount at regular intervals.
When the market is down, the investor gets a little more.
When the market is up, the investor gets a little less.
Interestingly, in volatile (and mostly rising) markets, the result of spreading an investment over time is usually better than just putting in a lump sum at the beginning and letting it sit.
That is what the Average in Dollar Cost Averaging refers to.
The usual disclaimers about averages apply, of course; namely, there is usually the same amount above the average as there is below!
This is a strategy, like most others, where it is possible to lose some or all of an investment.
Automate It!
The best thing to do with DCA is to automate your process!
Because everything is fixed, this is usually very simple to do.
And by making everything automatic, you’re likely to avoid these traps:
- forgetting to do it
- choosing to spend the money on something else
- missing an opportunity
How often?
That’s entirely a personal preference and sometimes circumstances dictate the answer.
For example, if an investor is building a stake, it may be necessary to wait until enough money is built up to purchase the next instalment.
When the market is very volatile, my personal strategy with DCA leans toward investing small amounts more often.