The Power of Dollar-Cost Averaging
Buy high and sell low, if only it were that easy. However, by dollar-cost averaging as an investment strategy, you can neutralise short-term volatility for long-term gains.
What Is Dollar-Cost Averaging?
Rather than attempting to time the market to buy an asset, dollar-cost averaging (DCA) is a long-term investment strategy of incremental investments over a chosen period. By DCA, investors can reduce their risk to the volatility of the asset in the short-term.
An example of an investor using the DCA strategy is the following. An investor wants to build their portfolio and believe over the long-term that the UK economy will improve. Therefore, this investor decides as part of their portfolio, they will DCA into the Vanguard FTSE 100 (VUKE) each month until they retire. The investor hopes to benefit from the dividends from VUKE during their retirement to use for experiences. Additionally, as they believe that over the long-term that VUKE will increase, they would have built up a sizable amount of capital in this stock to hand down as an inheritance for future generations to benefit.
Although the returns will be significantly less than if this investor would ‘time’ the market correctly, they benefit from not being emotionally connected to the date of purchasing. If this investor thought they could ‘time’ the market and was wrong, they would lose money. After all, if we could ‘time’ the market, we’d all be very wealthy.
“[Investors] were heavily buying stocks when stock prices were high, then selling stocks when their prices were low” (Thaler and Sunstein, 2009, pg.132–133)
Furthermore, in Nudge by Richard Thaler and Cass Sunstein, they reference in the investment section of the book that investors that attempt to ‘time’ the market typically buy high and sell low. They demonstrated this by analysing the data of investors exposed to equities throughout the 1990s and early 2000s. The data illustrated that when an investor should be buying equities, they didn’t, and when the market is heating up, investors bought in. It wasn’t very rational or very ‘econ’ of them!
Dollar-Cost Averaging Cryptocurrencies
I have been interested in cryptocurrencies for a few years now, but I only started investing last year. With both Bitcoin (BTC) and Ethereum (ETH) recently achieving new all-time highs from 2017 and 2018 respectively, I have been curious to see the result of DCA between the two peaks.
I have decided in this research that the investor is DCA $100 at the start of every month at midnight. I have also assumed that the investor started to DCA on the month of the cryptocurrencies all-time high as they ‘bought into the hype’. That is why the BTC DCA begins in December 2017, and the ETH DCA begins in January 2018. Additionally, I am using the price data from CoinGecko for the respective cryptocurrencies
Dollar-Cost Averaging BTC From Dec 2017 — Now
The spreadsheet below accounts for the 40 transactions between December 2017 to now. Each line on the spreadsheet accounts for a year. I have included in the spreadsheet: the month of purchase, the price of BTC at 00:00 on that day, how much BTC was purchased that month for $100 and finally, the total amount of BTC for that year.
By DCA BTC from December 2017 until now would have resulted in an investor following this strategy with only $100 a month (around £72) just over 0.5 BTC or just under $25,800 (£20,000). With only $4,000 invested during this time frame, that’s an incredible 545% returned.
What I found interesting when creating this spreadsheet was that conviction is rewarding. During 2018–2019, BTC became heavily discounted but received widespread media criticism as a failed experiment. However, for an investor to benefit from this discount, they would have needed conviction as they would have researched BTC and believed in its philosophy and continued to buy, despite the risks.
I decided to include this graph as it demonstrates how cool compounding is. Despite the price of BTC increasing to its new, all-time high in February this year, the small $100 increments each month created significant end-value for the investor in this hypothetical.
Finally, I included this chart as I wanted to understand the general trend of BTCs price in USD between the peaks.
Maybe this information could be used in tandem with other cryptocurrencies to determine price buying opportunities. Ironically, I write this in a post about DCA and the inability to ‘time’ the market, but it would nevertheless be interesting to research.
As the trendline is making a positive incline, could a possible adjustment be made to DCA BTC? For example, when this graph has been enlarged, and the investor is about to make their monthly deposit can they change their strategy depending on the price of BTC? Therefore, when the price of BTC is above the trendline, should the investor invest half of their monthly deposit and then double the investment when the price is below the trendline?
Dollar-Cost Averaging ETH From Jan 2018— Now
The spreadsheet below is similar to the previous one, adjusted for ETH. As the price of ETH hit its all-time high a month after BTC, there are only 39 payments in contrast to the 40 with BTC.
Despite BTC and ETH being two different cryptocurrencies with alternative uses, their performance in USD terms is relatively the same. ETH only slightly outperformed, which was a surprise. I expected before creating these spreadsheets that one of the currencies would perform noticeably better than the other, which wasn’t the case.
In contrast to the same graph for BTC, there was a notable difference. That is with ETHs decline from its ATH in 2018, where the price in terms of USD declined considerably more than BTC. That resulted in being able to purchase more ETH during the bear market.
I suspect that ETH will hit a new all-time high in 2021, resulting in higher USD gains when compared to BTC if an investor followed this strategy beyond the publication of this article.
As the spreadsheet demonstrated, the change in ETH between the two ATH is significantly lower than BTC. The following graph can illustrate this as the trendline between the two peaks while acceding is less than the one for BTC. If ETH saw a similar increase to its ATH like BTC, then this trendline would have been greater, resulting in significantly higher gains in USD. Comparing BTC to ETH between these periods shows that the bear market was harsher on ETH.
Final Remarks
This article was a shorter piece that I did out of my curiosity. I have started to DCA, and I was keen to know how ETH and BTC have performed during the previous bear market. This piece has also generated a few ideas that I will work on in some capacity over the following weeks.
This research has demonstrated to me is that conviction is fundamental. When times are tough, it is key to carry on investing as the pay-off will be greater as a result. You don’t make the same gains as you would if you time the market, but you benefit from the stabilisation of volatility across the chosen period.
Cryptocurrencies are still in their infancy, but the potential upside associated with them makes the risk worthwhile for me.
If you have any questions, please comment below this post or connect with me on LinkedIn at https://www.linkedin.com/in/wilsonedwardc/
Legal Disclaimer: I am not a financial advisor. The advice here given is not financial advice even though my excitement might make it look like such.
For The Curious Mind
Nothing to suggest this time. Apologies. However, I do find the concept of compounding to be really interesting and would love to learn more about it. Maybe, you the reader, can suggest something on this topic for me?
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