When investing in cryptocurrencies, it is recommended for investors to implement a risk management strategy when investing in the volatile asset class. Common strategies include adopting a more diversified approach by spreading the investment over time in multiple purchases, such as Dollar-Cost Averaging (DCA) or Value Averaging (VA), instead of simply investing the funds all at once. DCA and VA are the fundamental investment concepts that new investors should know when starting off the investment journey. In this article, we will describe these investment strategies and the differences between them.
- What is DCA and VA?
Dollar-Cost Averaging (DCA)
DCA refers to the practice where investors invest a fixed amount of money periodically over regular intervals.
For example, one invests a fixed amount of money monthly (e.g., RM500 per month) for a year instead of putting a one-time lump sum of money into an investment. An investor does not look at the price level but will just keep investing in the asset.
This helps to take the emotional aspect out of trading and helps avoid the occurrence of rushing into a trade or revenge trading. This strategy is well known and has been recommended by experts like Warren Buffet when investing in a volatile market.
Value Averaging (VA)
VA is an investment strategy where investors set a plan to invest a larger amount of their funds when the price of the asset falls and invest less when the price rises.
A target growth rate is set beforehand for the portfolio, and the investment contribution rate is adjusted according to the price rise and fall to achieve the targeted growth rate. The investor will occasionally sell part of his assets as soon as the investment portfolio has reached the target growth level. This strategy was developed by Michael Edleson in his book Value Averaging.
- What are the benefits of DCA and VA?
- Prevent emotional trading. The practice helps you to commit to a recurring investment and gives investors a clear plan no matter how the market moves during the period.
- Low entry barrier. You apportion a sum of money every month that will compound over time. This is more affordable than immediately putting a large portion of your capital.
- Mitigate the overall impact of volatility. This practice essentially helps to average down your buy-in price and reduce the overall price volatility. After all, it is very difficult to predict the next movement of the market, especially in an asset class as volatile as cryptocurrencies, which may be affected by macro news such as regulation and adoption.
Both DCA and VA help investors to set a clear and defined goal that benefits them in the long run, as they may not be as affected by short-term price movement.
Although the VA approach is more versatile as the investor enters into a position when the price is low and exit a position when the price is high, an investor would have to fork out relatively larger sums of money when the market is declining to buy more.
The DCA approach is simpler and relatively easier to carry out as it neglects the price movement in the market as it involves just investing a fixed sum at regular intervals.
The main benefit of either of these two types of long-term investment strategies is that it enables investors to build their portfolios over time and mitigate the effects of fluctuation and volatility.