Dollar cost averaging (DCA) is an investment approach. An investor may have overheard a friend say, "I'm DCA Ethereum and Bitcoin right now," and what this means is investing a set dollar amount on a regular basis, regardless of the current price of the security.
DCA is similar to "fractional shares" in the stock market, which are investments in a fraction of a stock that allows you to diversify and invest in high-priced stocks with modest amounts of money.
The only difference is that instead of buying fractions of a share (i.e., ½, ¾, etc.) at an undetermined price, an investor purchases shares based on the dollar amount rather than the fraction.
Here’s an example:
Fractional buying using Ethereum (CRYPTO: ETH) at $1,243.88 (as of June 14). If an investor wanted to purchase half of one Ethereum, it would cost $621.94.
Using dollar cost averaging to buy Ethereum, if an investor wanted to buy $500 worth of the crypto, they would receive around 0.38 Ethereum, a unit fraction of 38/100 or 19/50.
With the use of DCA, the investor preserves $121.94 to be used to purchase Ethereum again if the overall price drops.
So, what are the benefits of DCA? There are several.
Lower cost
Investing set dollar amounts in market assets when prices are falling offers the potential of a more significant return, that is of course if the security doesn’t fall further.
Barrier of entry
In March 2021, GameStop Corp (NYSE:GME) had its worst day, with shares losing 40% of value in just 25 minutes. Because market volatility is difficult to foresee, the DCA technique aids in the cost of purchasing.
Revenge Trading
In behavioral theory, the phenomenon of emotional investing, or revenge trading, is not uncommon. It is caused by various things, including chasing the stock, making a large lump-sum investment and loss aversion.
Risk reduction
Dollar cost averaging lowers risk while preserving wealth in the event of a market meltdown. It conserves funds, allowing for greater liquidity and flexibility.
The most significant benefit of DCA may be that an investor wouldn’t have to check the markets daily. An investor would make sure the price of the security is one they are comfortable with and then allocate dollars to it in set intervals.
Photo: Bakhtiar Zein via Shutterstock
