For cryptocurrency investors, volatility is a fact of life. But there’s an old strategy for these new investments that can take your mind off the ups and downs.
We’re talking about dollar-cost averaging – a classic investing strategy in which you make regular, smaller investments throughout the year instead of all at once. Traditionally, investors have applied the strategy to stocks, but experts say you can also apply it to crypto investments.
“It’s a great strategy, and it should be applied to something you believe in,” says Daniel Polotsky, founder of Bitcoin ATM and financial services firm CoinFlip. “Just do not put all your eggs in one basket. You should still diversify your wealth in case your decisions are not correct. ”
In general, experts recommend keeping your cryptocurrency investments to under 5% of your portfolio, and prioritizing more pressing aspects of your financial life, such as saving for an emergency, contributing to a retirement account, and paying off high-interest debt.
If you’re a crypto investor, here ‘s what you need to know about dollar-costing averaging and how you can apply it to your crypto strategy.
What Is Dollar-Cost Averaging?
For a long-term investor, a slow and steady approach is the way to go. That’s where dollar-costing averaging can come into play as it helps you focus on the benefits over time rather than the ups and downs of a day or week.
The strategy involves dividing up your total investment into small increments and investing them in the market regularly. For example, if your yearly goal is to invest $ 1,500 into Bitcoin, you would contribute around $ 125 a month throughout the year. But you can break those contributions down even further to be weekly or daily.
With dollar-cost averaging, you’re setting recurring buys at regular intervals for a fixed dollar amount, and you’re buying both the highs and lows. If the price of your investment drops during the time you are dollar-cost averaging, then you stand to make a profit if the price moves back up.
For many people, dollar-cost averaging is the most realistic and accessible way to ensure that they’re getting into the market with a reduced level of risk, especially if they have a longer-term time horizon.
How Dollar-Cost Averaging Works for Crypto Investing
Experts agree that dollar-cost averaging is a safer method of crypto investing than lump sum buying and selling. It’s lower risk and oftentimes lower reward, but still offers the chance of benefiting from market swings.
“If you put a certain amount of money in Bitcoin every single week since 2010, you’d be one happy person right now. If you did it over the last year, today you may not be happy, but maybe in a few months you would be incredibly happy, ”says Ron Levy, CEO of The Crypto Company, a firm that provides consulting services and education on blockchain technology .
Dollar-cost averaging, like any strategy, is only going to be a good one if your investment increases in value over time. And because crypto is still a new, highly speculative asset, it’s difficult to know if it will be a profitable investment in the future, says Levy.
“Oftentimes the past predicts the future. And in this case that may or may not be right because Bitcoin’s first decade is so new that it’s not a trend yet, ”says Levy.
That’s why Wendy O, crypto investor and popular TikToker, suggests sticking to Bitcoin – the most valuable and commonly held cryptocurrency – when dollar-cost averaging crypto, unless you’re OK with more risk.
“For Bitcoin, I like the dollar-cost averaging strategy because I like Bitcoin long term. It is one of the more stable [crypto] investments that a person can make. “When we’re talking about dollar-cost averaging with altcoins, I think that carries a lot more risk to it,” she says.
That means buying a little bit of Bitcoin at regular intervals over time, no matter the price at the time. Doing so helps avoid the psychological stress of buying at, say, $ 60,000 only to see your investment lose 10% of its value in a day.
Benefits and Drawbacks of Dollar-Cost Averaging in Crypto
In general, dollar-cost averaging is a good strategy for investors with a lower risk tolerance. A steady dollar-cost averaging approach can particularly help crypto investors stomach the extra risk and volatility that comes with the crypto market.
It’s also a way to avoid trying to “time the market,” which studies have shown is very unlikely to be a winning strategy for investors. By building wealth over time, you essentially neutralize short-term volatility in the market emotionally and financially.
Here’s an example by crypto exchange Coinbase that shows how dollar-cost averaging can neutralize big drops in the market, allowing your investments to grow steadily over the long term, compared to lump sum investing:
If you invested $ 100 in Bitcoin every week starting on Dec. 18, 2017 near that year price peak, you would have invested a total of $ 16,300. By Jan. 25, 2021, your portfolio would be worth approximately $ 65,000 – a return on investment of more than 299%. If you had taken that same amount of $ 16,300 and invested it all on Dec. 18, 2017, you would lose nearly $ 8,000 throughout the first two years. Your portfolio would recover, but you would have lost out on the ability to compound your profits in the meantime and maybe even scared yourself into selling your Bitcoin at a loss.
But dollar-cost averaging crypto does have its drawbacks.
While dollar-cost averaging helps mitigate risk if the market crashes, less risk can mean less reward. In this way, dollar-cost averaging is not a strategy to maximize an investment return, but more a risk management strategy. If you’re comparing dollar-cost averaging to lump-sum investing purely on the basis of profit, lump-sum investing typically outperforms, multiple studies have shown over the years.
You may also have to pay more fees over the long-term using this strategy. Crypto exchanges charge fees when buying, selling, or trading crypto. Exchange fees are often a percentage of your trade and charged per transaction. For example, Coinbase charges $ 0.99 for every transaction of $ 10 or less. But fees can differ whether you’re the seller or the buyer, and there may also be different charges depending on which currencies you trade.
Before adopting this strategy, make sure you understand exactly how and when an exchange will charge you for your crypto transactions and determine how much you’re willing to spend on fees.