Dollar cost averaging (DCA) is a tool investors use for building wealth over time while minimizing the impact of short- and long-term volatility. In making an investment decision, an investor must consider the method to start with. An investor may choose to adopt the Dollar Value average system or the Dollar-cost averaging system.
What is Dollar Value Averaging?
Dollar Value Averaging simply means an investment strategy adopted by an investor to make regular investments to his portfolio according to changes in the value of the dollar. The investor plans out the amount on his portfolio in a period and invests to get the targeted amount in a period.
The amount of investment to be made is not fixed, it changes as the value of the dollar changes. When there is a rise in the value of the dollar the investor will invest less but when there is a fall in the value of the Dollar, the investor will invest more. The investment power over time is determined by a rise or fall in the value of the dollar.
This is an investment strategy that is similar to dollar-cost averaging but they are different. An investor who chooses the dollar cost average system may only increase his investment power when there is a fall in the market while his portfolio remains unchanged, his investment at intervals doesn't change.
The major difference between the Dollar Value Average is that in the Dollar Value average system, the investor invests according to the market direction while the dollar cost Average investor invests a fixed amount at the interval.
To better understand the Dollar averaging system, let us give an example.
Example Of Dollar Value Averaging
For example, Mr. D is a cryptocurrency investor who has a target to acquire $10000 worth of Bitcoin in his portfolio. Let''s assume that the current price of one Bitcoin is at $45,000.
So as the price of one Bitcoin is at $$45,000, Mr. D decides to buy $1000 worth of Bitcoin. If the price of Bitcoin increases to $49,000 or above the initial price when Mr. D bought he will not buy.
Now when the value of one Bitcoin falls below $45,000 the initial entry point when he bought, Mr. D will then buy.
Investors decide to adopt the Dollar Value Averaging strategy for various reasons. Let us discuss a few reasons why they may choose this strategy below.
Reasons Why Investors May Adopt DCA Strategy
Investors may decide to adopt the Dollar Value Averaging strategy for the following reasons:
Market Direction: The Direction of the market determines the investment power of an investor. When there is a rise in the value of the dollar, the investor enjoys a surplus.
Portfolio Target: To balance the portfolio, the investor will only multiply his deficit or surplus with the targeted portfolio and invest accordingly.
There is no fixed investment amount.
Long-term investment: The investor enjoys long-term investment as he makes up the deficit with surplus and continues to reinvest.
Emotional Balance: The investor is not under pressure to invest an exact amount of money at intervals, they rather invest according to the value of the dollar in the market. This helps them stay emotionally balanced even in the dip.
Due to the nature of using one’s hard earned cash for purchasing assets, investing can be a highly emotional practice. As a result, dollar cost averaging can help mitigate the reactivity and impulsivity that may happen from trying to time the market.