Understanding Cost Averaging – When investing in crypto assets, there are many ways and strategies you can do to avoid losses. One way is by way of cost averaging or also known as dollar cost averaging.
In addition to being able to help investors become wiser in managing investment spending, this method can also avoid impulsive decisions based solely on emotion. Then, what is the meaning of this cost averaging and how to do it?
Definition of Cost Averaging
The definition of cost averaging or dollar cost averaging is an investment strategy with a simple method, which allows investors to invest regularly within a certain period. This one investment strategy will make it easier for investors to be more disciplined in allocating investment funds every month or every certain period on a regular basis. That way, investors no longer need to pay attention to falling or rising prices, they will remain consistent in investing.
In investing, investors cannot really predict price movements of investment instruments in the capital market. Therefore, investors need to carry out a special strategy in order to get optimal returns.
Often times, novice investors question the right time to buy and sell their investment assets. With this Dollar Cost Averaging investment strategy, it can be one of the best solutions for novice investors in investing.
When investing in mutual funds, you can invest regularly without paying attention to movements in the value of the mutual funds. If you save regularly a certain amount, then you can reach your investment goals more quickly.
For example, when you prepare an emergency fund by investing in mutual funds in the money market, you can allocate 500 thousand of your income for mutual fund investments. By implementing this strategy, you can measure the investment timeframe according to your goals.
Benefits of Dollar Cost Averaging
By implementing a dollar cost averaging strategy, you will get the following benefits:
1. Friendly for Beginner Investors
The way dollar cost averaging works is almost the same as saving activities, so novice investors can allocate their funds in the same amount in any situation. This can make it easier for novice investors who tend to often feel hesitant to invest or are new to the investment world.
2. Reducing Investment Risk
Beginner investors are often worried and afraid to allocate their investment funds. On the other hand, investors also often guess the best time to invest. This dollar cost averaging strategy is one strategy that is quite effective in optimizing returns in the long term. In that case, this dollar cost averaging can minimize the risk of changes in the value of your investment portfolio, so that the average value you will get is not too low.
3. Avoiding FOMO
Often an investor feels FOMO (fear of missing out) or is afraid of missing a moment or afraid of losing, so they take emotional steps or decisions. Apart from incurring losses due to changes in the value of your investment portfolio, you can also lose psychologically because you constantly regret the decisions you have made.
Therefore, this one investment strategy can avoid fear and the trend of choosing the right time. That way, you won’t be trapped in fear and worry about missing moments or depression when investing.
4. Invest in installments
It might sound impossible, but this dollar cost averaging allows investors to invest even though they don’t have all the funds. Because, large funds will be invested in stages, so you can make investments in installments or little by little.
5. Avoiding the Wrong Time Selection
Investment in a lump sum or all at once will indeed provide a large return. However, you have to understand when is the right time to do it. As we already understand, it is very difficult to understand the highs or lows of a price.
With this dollar cost averaging, you will not be too exposed when you buy at high prices and when the market is corrected, you have already bought it. In fact, without having to observe the market, you will still be able to make investments.
This dollar cost averaging strategy is independent of time and minimizes the effect of market volatility on your portfolio because your average return will be neither too low nor too high.
Disadvantages of Dollar Cost Averaging
Each investment strategy certainly has its benefits and drawbacks. The following are some of the shortcomings in the dollar cost averaging strategy, including:
1. Relatively Small Return
The market has a tendency to move up. When compared to lump sum investment, this dollar cost averaging strategy will provide a relatively small level of profit.
2. Greater Investment Costs
In a lump sum investment, you only need to make an investment at a certain time that you think is right. However, in this dollar cost averaging strategy, you have to invest regularly. If every purchase transaction is charged a fee, then you have to pay fees regularly. Therefore, when compared to lump sum investments, the costs required for this strategy are certainly greater.
3. Market Value Tends to Increase
When compared to other strategies, dollar cost averaging offers returns that tend to be small. Moreover, if market conditions continue to move up. When you continue to increase the investment volume when the price goes up, the average price you get will also be higher. This will reduce the potential returns that you should get.
As a result, in the long term, the level of profit will be smaller compared to the lump sum which has a larger profit. As the market goes up, using a dollar cost averaging strategy, you might feel sorry for not maximizing your investment from the start.
4. Including Passive Strategy
This one strategy will make you a passive investor. In addition, you also do not respond to market conditions and situations that are constantly changing. For example, if there is an acquisition, economic crisis, and also other events that can affect prices.
So, the dollar cost averaging strategy is more suitable for investors who don’t want complicated methods. If you are classified as a passive investor, but still want to get a definite profit even if the amount is not too much, then this dollar cost averaging strategy is the right choice.
5. There is an Investment Cost
Next, there is also a drawback to dollar cost averaging, namely the existence of investment costs that must be paid regularly. For example, when you use investment funds for stocks, you will be charged a specified amount for each purchase.
If later you often buy stocks, the investment costs incurred will also be even greater. Even though the stock transaction fee is actually relatively small, if you add it up it will feel big too.
How Dollar Cost Averaging Works
The dollar cost averaging method is quite easy to implement. So, initially you only need to choose what instrument you want to invest in. For example, stocks, mutual funds, crypto, and so on. After selecting the instrument, then you have to set the investment capital.
For example, if you plan to make an investment with a capital of 12 million, in dollar cost averaging you will not put all of that money together. However, you only need to start with 1 million Rupiah every month for 12 months.
Next, during the implementation of this strategy, market conditions can fluctuate, be it bullish or bearish. However, you can still walk without caring about these conditions. If the market is in a bearish condition, then the profit opportunities are quite large in the future. In general, this dollar cost averaging strategy is suitable for those of you who don’t want to be complicated and want to invest more passively, but still make a profit.
Saving regularly and consistently is the most appropriate strategy for novice investors. The longer you invest, the greater the amount of money you save and the maximum return.
You don’t need to rush to get rich and get a lot of profit, because investing does take a long time. The investment decisions you make right now will have a big impact if done consistently.
Is the Dollar Cost Averaging Strategy Profitable Enough?
The dollar cost averaging strategy can help investors avoid making impulsive decisions that can lead them to losses. Not only that, this strategy is also quite ideal for long-term investors. The goal is to stick to investment cycles, where you keep investing the same amount consistently in one asset.
Apart from that, it should also be understood that dollar cost averaging is more effective when the market is bearish. While most investors are too afraid to invest in these conditions. This dollar cost averaging will provide an investment framework for buying dips.
Is Dollar Cost Averaging Suitable for Crypto Investment?
As we discussed earlier, the dollar cost averaging strategy is perfect for all types of investments whose prices change easily, including crypto assets. Therefore, it is not easy to predict possible price movements in the market. That is why investors may need to adopt this strategy to even out buying prices and take advantage of market downturns.
However, it should be noted that investors will not suffer significant losses during a bullish cycle. In addition, note that the dollar cost averaging strategy will become stronger when digital asset prices decline.
To be able to use this strategy as a strategy for investing in crypto, you can choose an intermediary service that offers periodic purchase options. Apart from that, you can also manage purchases manually by selecting a fixed amount to invest by selecting a fixed amount to invest at predetermined intervals.
Example of Dollar Cost Averaging
To make it clearer, the following is an example of a dollar cost averaging or DCA case.
For example, you want to invest Rp. 10 million in gold, but not sure when is the right time to buy it. By using the dollar cost averaging strategy, you can buy gold with Rp. 2.5 million every month, from April to July.
As we understand that the price of gold fluctuates. Here the average cost in four months to be able to buy gold per gram is Rp. 835.236 per gram. With this method, you can regularly buy gold every month without worrying about whether the price of gold is going up or down.
Another example is when you want to buy stock A, but you don’t want to put in a nominal investment amount at once, or you don’t have a large amount of money. So, you can commit to doing a dollar cost averaging strategy by investing Rp. 200 thousand per month for 5 months. For example, as follows:
- Month 1: The initial share price is IDR 1,000, you buy 2 lots.
- Month 2: The value of the stock price increases by IDR 2,000, you buy 1 lot.
- Month 3: The value of the stock price drops to IDR 500, you buy 4 lots.
- Month 4: The value of the stock price increases by IDR 650, you buy 3 lots.
- Month 5: The final share price is IDR 1,000, you buy 2 lots.
Then, at the end of the fifth month, you get 12 lots at a price of Rp. 1 million. If you directly invest Rp. 1 million as usual in the first month, then you can only get 10 lots. That way, you can also get a profit worth 2 lots with this dollar cost averaging strategy.
The minimal risk offered by this strategy can more or less help novice investors in maintaining emotional stability when investing. You don’t need to worry too much that you always check your portfolio continuously because of the large capital that is embedded in an instrument.
This dollar cost averaging can also train self-discipline as an individual investor. With a commitment to invest consistently according to the target of obtaining greater returns in the future, then like it or not you have to work around the budget so that you can routinely carry out investment habits.
By getting into the habit of investing regularly and consistently by analyzing the stock market first, you will also train yourself so you don’t get caught up in the desire to buy a particular issuer when a rally occurs. Apart from that, you are also not easily influenced by positive sentiment towards something whose performance and prospects still need to be tracked.
Things to Look For in Using the Dollar Cost Averaging Strategy
The only major weakness in the dollar cost averaging strategy is the increase in transaction costs. Because this one strategy requires a lot of purchases, the trading fees charged can also increase significantly, especially when using a crypto intermediary service to exchange fiat to crypto assets.
However, it depends on the profitability and duration of the investment you make. Maybe you don’t necessarily feel the effect of the additional overhead costs that arise from buying periodically compared to buying it all at once.
There is also the potential for loss as a result of a fairly consistent spike in asset prices. The higher the purchase price over time, the smaller the perceived impact of using this dollar cost averaging strategy.
This is an explanation of the meaning of cost averaging in investing.