Dollar Cost Averaging: How profitable is this strategy really?
Dollar Cost Averaging is a term used to describe a very popular investment strategy. It is designed to help you build up a certain position size (= the amount of an asset you own). At the same time, it protects you from the influence of short-term volatility. Therefore, this method is great for investing in Bitcoin, as Bitcoin is a very volatile asset.
In this strategy, you periodically divide the amount of money you want to invest in bitcoin in total into equal amounts. The current price of bitcoin doesn’t matter in the dollar cost average investment strategy. The only constant in this method is the time interval.
How does the Dollar Cost Average strategy work?
The investment period is divided by you into clearly defined time intervals, and at the end of each interval you invest the same amount of money again. As already mentioned, the current price does not play any role in your investment decision. The time interval is determined by you and your deposits can be made, for example, on a weekly basis or after every month.
Alex has saved $1,200. He is a big Bitcoin enthusiast and also sees Bitcoin as a wonderful opportunity to multiply his money. With positive predictions for the Bitcoin price, supported by named methods such as the stock-to-flow ratio, Alex sees himself confirmed in his belief that it is not too late to invest in Bitcoin and that the price of Bitcoin will continue to rise in the long run. Therefore, he decides to invest $100 every month in Bitcoin for an entire year.
However, Alex doesn’t know much about reading charts, so he is afraid that right now might be a bad time to buy Bitcoin. After all, he knows that Bitcoin is very volatile and the current price can change a lot from one day to the next. Therefore, Alex decides to use Dollar Cost Averaging as an investment strategy to best protect his money from the price fluctuations.
He sets up a plan for himself to invest $100 in Bitcoin on the 1st of every month. He doesn’t care whether the price of Bitcoin seems high to him right now or not. On the 1st of each month, he will buy, come what may.
How profitable is Dollar Cost Averaging in practice?
In theory, the Dollar Cost Average strategy sounds nice and simple, but how efficient is this method in real markets? Let’s back up the practical example above with numbers by using real Bitcoin prices to check how well Dollar Cost Averaging would have worked as an investment strategy for Alex if he had started it exactly one year ago. To do this, we assume that Alex started investing $100 in Bitcoin on the 1st of every month exactly one year ago.
If Alex had decided to invest his $1,200 in Bitcoin in one fell swoop on November 1, 2018, he would have received 0.18992931 BTC in return, which was equivalent to $1576.36 on October 1, 2019. He would have earned a return of 31.36% after all. However, our numerical example shows that Alex was able to achieve a much better performance of 51.15% using Dollar Cost Averaging as an investment strategy.
What are the advantages and disadvantages?
As with any investment strategy, there are circumstances with Dollar Cost Averaging as an investment strategy that speak for and against its use. Below you will find a listing of its main advantages and disadvantages, which can help you determine if using this strategy is right for your venture.
Advantages of Dollar Cost Averaging:
- Dollar Cost Averaging is a great way to invest during times of great uncertainty and volatility. It eliminates the uncertainty of whether or not you are just buying at a good time.
- It provides you, the investor, with a mathematical average for your investment decision and saves you from being guided by emotions.
- The Dollar Cost Average strategy saves you in the long run from unfortunate market entries and the negative feelings that come with them. Just imagine if Alex had invested all his money in Bitcoin when Bitcoin was at its all-time high.
Disadvantages of the Dollar Cost Average Strategy:
- If there is a clear uptrend, dollar cost averaging as an investment strategy performs worse than most other methods in the short and medium term.
- For dividend-bearing assets, the dollar cost average strategy faces additional opportunity costs.
Is dollar cost averaging the right investment strategy for you?
- Do you want to invest rather than actively trade the market?
- Does high volatility rule the market you want to invest in?
- Are you unsure about the direction of the price in the near future?
- Do you have a tendency to let emotions guide your buying decisions?
- Do you like to keep your strategy as straightforward as possible?
The Cost Average Effect
Everyone may know it. The crypto market is experiencing one of its rocket-like bursts and you get scared of missing the flight to the moon now. Top returns seem to be running right out from under your nose, but maybe there is still a chance to jump on quickly? Most of the time, however, this decision, also called FOMO (Fear of Missing out), leads to disaster in terms of portfolio performance. The best example was the Bitcoin explosion at the end of 2017, when everyone jumped on all sorts of cryptocurrencies hoping for financial independence.
How that story turned out most of us know by now. Whether affected themselves or not, the sad faces, some of whom are still carrying around their “bags” of altcoins today should be a brand. HODL or “buy the dip” were slogans that were laughed at by some, but they hit the mark once again with Bitcoin. For those who followed a Bitcoin savings plan were able to acquire extremely cheap Bitcoins for around USD 3,300 at the end of 2018 and thus make up for supposed bad purchases at USD 20,000.
We state: People often behave irrationally. They are psychologically suggestible and often swim with the crowd. Interest arises when prices rise. This is understandable, but from an economic point of view it is below the optimum.
And besides, how could anyone have known that January would have been the best month to buy? When is the best time to invest anyway and should you invest all at once or rather in monthly installments? We’ll tell you: Always! And the best way to do that is with a Bitcoin savings plan.
A bitcoin savings plan?
A Bitcoin savings plan is in our opinion one of the best things you can do to your portfolio and performance. This is especially true for Bitcoin and less so for altcoins, because BTC, unlike some alternative cryptocurrencies (altcoins for short), already has more than 11 years under its belt and one or two crises behind it. Bitcoin is “here to stay,” meaning it has come to stay. So if you are in the high-risk crypto environment and looking for investment opportunities, buying BTC directly is certainly not a bad decision.
A Bitcoin savings plan can be quite “cool”, because what is better than a top portfolio performance with which you also save a lot of nerves. A savings plan actually has little to do with savings books and rather reflects a simple and effective investment strategy that has proven itself for many decades.
The basis for a successful Bitcoin savings plan is, in addition to consistency, the advantage that prices move in waves. These waves are taken both up and down, if you do not wait for THE right time, but buy Bitcoin regularly. We are talking about the Cost Average Effect, which we will explain and prove in the following. The result will amaze you!
Bitcoin (BTC) Price Forecasts
Before we get down to the nitty gritty, let’s take a quick look at a topic that is sure to interest you the most: The Bitcoin price and possible forecasts. For many, they form the basis of an investment decision, whether Bitcoin savings plan or another strategy.
Forecasts are (at best based on data) predictions about potential developments in the future. However, since no one has a crystal ball and really knows what will happen, forecasts remain just forecasts. So it is very speculative to make an investment decision based only on forecasts.
If you have read this article so far, it should be clear to you that it is neither a good idea to make overzealous and spontaneous purchases, nor to rely on forecasts or even to go all-in because analysts see Bitcoin soon at $100,000. So what is a good idea? How should I invest in bitcoin? What is the best strategy? Does a bitcoin savings plan make sense for me?
- Are you a trader looking at the market for the next few minutes or hours?
- If you are a trader, how many hours can you spend in front of the charts?
- Are you an investor because you plan to participate in the market for the long term?
- Do you believe in decentralization and blockchain?
- Do you believe Bitcoin could become the new digital gold?
The stress-free investor
And as an investor, we would now like to introduce you to one possibility of a long-term BTC investment. The Bitcoin savings plan or also known as investment according to the Cost Average Effect.
In our opinion, a Bitcoin Savings Plan or Cost Averaging is one of the best ways to invest in a market that you believe has long-term value. It saves you as an investor a lot of stress and time, with (very) good results at the same time.
The basic principle behind it is simple: you regularly buy a cryptocurrency with an amount of euros you set over a long period of time. Bitcoin is the best way to prove this effect, as BTC has the longest and most “consistent” history.
Admittedly, a Bitcoin savings plan does not reinvent the wheel. Even though this strategy has been preached for decades, it is rarely used. Often, this is because individuals have a lot of confidence in themselves and think they have found a good time to invest. Let’s just take a look below at how cost average investing has performed in different market phases and why it is one of the safest investment strategies.
Cost Average in a Bear Market
Let’s first look at investing in a bear market. We will compare an all-in investment with a bitcoin savings plan or a cost average investment.
Strategy: All-In at a Point in Time
Imagine you heard about Bitcoin for the first time during the 2017 bull run, got excited and wanted to participate in it (= buy Bitcoin) right away. Not wanting to waste any time, you invested your available $1,000 right at the beginning of the new year.
Investing in January 2018 at a Bitcoin price of $13,886, you received 0.072 BTC. This would equate to a value of approximately $900.00 at the current time (BTC=$12,500).
Strategy: Cost Average
As mentioned above, the Cost Average approach is more structured and deliberate. The thought behind it can be well connected with the well-known quote of the economist Markowitz. He said: “Never put all your eggs in one basket”.
So let us now assume the same scenario: One decides to buy Bitcoin for the first time in January 2018. Due to the Bitcoin savings plan strategy, however, you do not do this all at once, but divide your investment into 10 monthly installments of 100 dollars each.
At the end of the investment period of 10 months you would now have 0.123 Bitcoin. This would correspond to a value of approx. 1537.00 $ at the current time (BTC=12,500 $). Not only would you have 0.05 Bitcoin more, but you would also have 53.7% growth as well as less stress.
Now let’s look at what happens in a bull market. Is the cost average effect still a good decision then?
Cost Average Effect in a Bull Market
Strategy: go all-in at one point in time
Imagine you heard about Bitcoin for the first time at the end of 2016, you were excited and wanted to participate in it right away. Not wanting to waste any time, you invested your available $1,000 directly on the first of January 2017.
Investing in January 2017 at a Bitcoin price of $972, you received 1,028 BTC. This would equate to a value of approximately $12,850.00 at the current time (BTC=$12,500).
Strategy: Cost Average
So now let’s assume the same scenario: One decides to buy Bitcoin for the first time in January 2017. Due to the cost average strategy, you do not do this all at once in a Bitcoin savings plan, but rather divide your investment into 10 monthly installments of $100 each. This time, however, we are in a bull market.
At the end of the investment period of 10 months, you would now have 0.558 Bitcoin. This would correspond to a value of about $6,975.00 at the current time (BTC=$12,500). So you would have about 0.5 Bitcoin less than with a one-time investment. So here, the one-time investment performs better compared to DCA – but for both, the results are tremendous.
How can these results be interpreted?
Well, it’s hard to say. Investing according to a bitcoin savings plan is extremely valuable and worthwhile when we are in a bear market. In a bull market, the cost average effect (as shown in the example above) cannot match a one-time “FOMO” investment at a good time.
And this is where we come full circle and the same questions confront us again: How can I know if a bull or bear market is imminent? Are we currently in a transitional phase from bull to bear market or is it even the other way around?
Of course, there are always indications for a respective market phase and a downtrend lasting for months can confidently be called a bear market. However, the unsatisfactory answer that must be given here is: Nobody really knows where the market is going and what will happen next.
A reasonable risk-reward ratio is rarely offered by an all-in move; greater opportunities always offer greater risks. However, a healthy middle ground with a long-term strategy is much less likely to disappoint you than an all-in move. Let’s look at one last scenario.
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From Bull to Bear Market
The final example: How does a Bitcoin savings plan or the Cost Average strategy behave when we move from a bull market to a bear market. For this, we look at the period from October 2017 (bull market) to August 2018 (bear market).
If you made an all-in investment in October 2017 at a Bitcoin price of $4,281, you received 0.233 BTC. This would equate to a value of approximately $2,994.80 at the current time (BTC=$12,500).
At the end of the investment period of 10 months, you would now have 0.111 Bitcoin. This would equate to a value of approximately $1,387.00 at the current time (BTC=$12,500). Again, the one-time investment performs better compared to a Bitcoin savings plan.
It’s not always about the money
Investing based on your emotions may be more fun, but it has been shown time and time again that it can be (and is) very dangerous. As dramatic as the following words sound: Investing is not only (but of course for the most part) about the financial aspect. In a way, it is also about “peace of mind.” Investing should not at any time be a psychological burden, make you sleep badly, or take center stage in your life. Investing is also about discipline and keeping emotions away.
Imagine: The price goes up from $4,300 to $20,000 within two months (October 2017 – December 2017) and then crashes back down to $3,000 (December 2018). What would you have done? Would you have stayed calm and realized some of the gains at $20,000 or would the greed for more have grabbed you? The message here should be: When you invest in a market without a strategy and plan, it becomes enormously difficult to make rational decisions. A bitcoin savings plan can be very helpful there.
Use Cost Average and Sleep Easy
If one invests according to the Cost Average strategy, one reduces the general risk of short-term fluctuations. In a bear market this is of course advantageous, although it is annoying in a bull market. As our examples have shown, a Bitcoin savings plan greatly reduces the likelihood of large losses. However, it also makes a “lucky shot” less likely. Summa summarum: If you call yourself a long-term investor and want to act emotionless in the market, you should look into the Cost Average strategy.