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Dollar Cost Averaging (DCA) Explained

Dollar Cost Averaging (DCA) Explained

How to Conquer Fear and Greed in Investing

First, let’s start very simple.

Invest: verb. To expend money with the expectation of achieving a profit or material result by putting it into financial plans, shares, or property, or by using it to develop a commercial venture.

Sentence: “He invested half of his savings into shares of Apple stock.”

In the past few years, retail investors (normal people like you and me, as opposed to large companies or wealthy individuals & families) have become more involved in investing and trading in markets. One reason is that the interest rates offered in most bank accounts is less than 1%. So, there is the possibility of a regular person getting a much higher return by investing, as opposed to saving. Those seeking a higher reward (which comes with higher risk as well) have been turning more and more into stock markets and especially recently into Bitcoin and other cryptocurrencies.

A number of apps such as Robinhood, Stash, Acorns and SoFi have made it easier for any beginner to get involved in investing in stocks. Others such as Coinbase, Gemini, CashApp, Binance and Kraken have made it possible for everyday people to invest in cryptocurrencies such as Bitcoin, Ethereum and others.

The trend of retail investors accelerated March 2020, at the beginning of COVID lockdowns, with millions of retail investors with time on their hands and stimulus checks jumping into the markets.

2021 has seen ever more new investors jump in.

Some big things that have happened:

2020

The S&P 500 index rose 16.26%
The NASDAQ composite index rose 43.2%
Tesla stock increased 743%
Etsy stock increased 302%
Bitcoin increased 450%
Ether increased 733%

2021 Investing Key Facts:

Bitcoin increased 98% year-to-date (YTD)
Ether increased 101% YTD
Theta (a cryptocurrency) increased 584% YTD
GameStop stock increased 1,089% YTD

Two Big Threats to Investor Success: Fear & Greed

Fear and greed are powerful factors affecting investors and traders.

Experienced professional and retail investors and traders are well aware that emotions can take over and cause one to make terrible decisions. Emotions are very powerful, and I know from experience that these can cause one to make bad decisions in a flash. Smart, experienced traders and investors handle this by having an exact plan and sticking to it. And even then, emotions can still get the best of them if they are not aware.

There are two acronyms that are important because they describe two things that can cause one’s emotions to take over and thus make bad financial decisions. These are FOMO and FUD.

FOMO = Fear of Missing Out

FOMO - Fear Of Missing Out

This is what it sounds like. Have you ever felt like all your friends were doing something and you were missing out. They all saw a movie and you didn’t. They all joined the latest social media app, and you didn’t. What do you feel like doing? Join in, of course, and RIGHT NOW!

In investing, this can be especially dangerous. For example, when you looked at some of the figures above, such as GameStop, you might have thought, man if I had put $1,000 towards those shares at the beginning of the year, I would have over $10,000 right now! If you then had the urge to immediately put a chunk of money into GameStop shares, that’s normal, that is FOMO. That is greed taking over and it happens to all of us.

In the shorter term, someone might be following the price of a stock that just doubled so they buy a ton of that right now, in hopes that it keeps going up. It might, and it might now. It might also drop 30% in an hour.

FOMO of course can be contagious, especially with millions of retail investors on social media such as Facebook, Telegram, Twitter and Reddit.

FUD = Fear, Uncertainty and Doubt

FUD - Fear Uncertainty and Doubt

This is kind of like the opposite of FOMO, but just as irrational. You get that sinking feeling in your stomach that all your investment is going to zero, and you better sell it all now. In the example above, let’s say FOMO took over and emptied out your bank account and put $1,000 into a cryptocurrency and it drops 30% over a few weeks. You panic and sell it for $700. If this cycle repeats itself too many times, you can find yourself having lost all your money.

FUD can also be contagious and cause a crashing price to crash faster as more people sell.

What can you do about these two threats? There is a simple solution, whether you:

  • Are brand new to investing or trading
  • Don’t have the time to spend looking at price charts
  • Don’t want to get sucked into staring at price charts all day.

It is called Dollar-cost averaging, or DCA.

What is Dollar-Cost Averaging (DCA)?

Dollar Cost Averaging (DCA) Explained - DCA

Dollar-cost averaging (DCA) is an investment strategy in which an investor decides to invest a set amount of money over time. They decide that they have found a good investment. They don’t try to figure out when is the exact tight time to buy, and when it will go up and when it will go down. They decide the amount they want to invest and divide it up over time. This way, one is not impacted as much when the price rapidly goes up or down or down in the short-term. The purchases occur regardless of the asset’s price and at regular intervals. This also takes less time since one is not staring at charts. One can even set this up on some of the apps mentioned above, with automatic investing.

DCA is also known as the constant dollar plan. The success of DCA is based on whether the investment will grow over time. Of course, if it goes down over time, one’s funds will also become less.

Example #1:

Mary works at a job and has a paycheck of $1,400 every other week. She decides to put 5% or $70 of her bi-weekly paycheck towards Apple stock for the next two years on her Stash app. If she did this two years ago, she would have put $3,640 towards Apple stock.

DCA $70 every two weeks into Apple stock (approximate)

That $3,640 would have now grown to over $6,300. That is 73% or 36.5% growth per year by dollar-cost averaging into Apple stock.

In contrast, the average hedge fund (a limited partnership of investors that uses high risk methods, such as investing with borrowed money, in hopes of making more money faster.) only grew 6.96% in 2019 and 11.6% in 2020. That hypothetical amount of money would have only grown to $4,344. Hypothetical because hedge funds charge fees and would only be open to qualified investors. In the above example, Mary would have beaten the hedge funds by an average of over 27% per year over the past two years! And simply by investing in the most valuable public company in the US, not exactly a lucky stock few have heard about.

Example #2:

Jose owns his own business and has $300 per month over his expenses he can invest. He decided to invest in Bitcoin. Instead of looking for the dips, he decides to invest $300 every month into Bitcoin on Coinbase. Bitcoin, for example is up 1137% since March 16, 2020. After 13 months, Jose’s $3,900 investment would be about $19,900.

DCA at $300 per month into Bitcoin (approximate)

Jose did this by being lazy and didn’t take much risk. He didn’t study about how to read charts. He didn’t need to be a millionaire or an economics graduate. He simply decided to invest in Bitcoin and that the price was likely to go up over time. And in this case, he beat most experts.

In summary, here are the benefits of Dollar Cost-Averaging (DCA):

1. Risk reduction
2. Lower cost
3. Ride out market downturns
4. Disciplined saving
5. Prevents bad timing
6. Manage emotional investing (conquer fear & greed)

A disciplined buying strategy through DCA makes the investor focus their energy on the task at hand and eliminates news and information hype from various media about the stock market’s short-term performance and direction.

In the current market environment, investments and stocks offer potential greater gains than the near zero interest rates available to the average person in their bank account. This does also come with risk. It is my personal opinion (not financial advice) that investments such as Bitcoin and other assets such as stocks will continue to increase, based on the prevailing economic policies of central banks in the US, Europe, Japan and elsewhere. A great way to get involved and remove part of this risk is through dollar-cost averaging.

A great way to DCA in Bitcoin is to use my link and sign up for Swan Bitcoin, whose business model is literally helping you DCA.

Have fun and good luck!

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This article is not investment advice, nor does it take your personal financial situation into account. Never invest more than you are willing to lose, and don’t buy Bitcoin or other investments on credit. I write about my observations and personal opinions with the purpose to share what I have learned with others.

Disclosure: I am invested in Bitcoin and other cryptocurrencies as well as stocks including Apple.

Author

Alexandre Lores is a personal finance writer from Tampa Bay, Florida, with the goal to help one million people achieve financial freedom. He has spent over five years studying markets and economics, finding Bitcoin in 2017 and never turning back. He frequently appears on TV and in online news articles and is a regular Twitter spaces host.

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