Dollar cost averaging (DcA) is a strategy used by investors to reduce the downside risk of placing large sums of money into the market at once.
While this can take the form of regularly purchasing a single asset, we’ll be looking at the technique from the perspective of a portfolio. Consider it a way to add new money to a portfolio on a regular basis.
A dollar-cost averaging technique will divide the injected money throughout portfolio management based on a specified list of target allосatiоns.
HOW DOES IT WORK?
To further understand this method, let’s break down each of the steps that occur during a dollar-cost averaging event.
DETECTION OF DEPOSIT
DcA would only run if a deposit had been discovered. We may check every 15 minutes to see if any new funds have been added to the portfolio. When a deposit is discovered, a DcA is triggered.
We’ll record the value of the asset that was deposited at the time of detection. The DcA will only use this depreciated money to conduct transactions in the coming phases.
ALLOCATION OF FINANCES
We’ll take the deposited dollars and figure out how to distribute them for the dollar-cost averaging technique now that the deposit has been noted. There will be no further assets or money transferred during the DcA’s execution.
Based on the current allосatiоns of our portfolio and the following goals, we can figure how much of the deposited money should go to each of the assets in the portfolio to achieve our goal.
After the required transactions have been identified, each individual transaction will be conducted to ascertain the goal. Any funds left over at the DcA’s conclusion as a consequence of unsuccessful transactions or minimum trade limits will be invested in the deposited asset.
Let’s take a look at how DcA works using a pоrtfоliо simulation as an example.
Let’s say we’ve got a $100 investment portfolio. This portfolio now has a balanced distribution of five distinct assets, each worth $20. As a consequence, the pоrtfоliо may be said to now have 5 assets allotted at 20% each.
HOW CAN IT BE USEFUL?
Dollar-cost averaging is a pоrtfоliо approach that allows money to be quickly detected and allocated. The funds are distributed in such a way that they assist the portfolio’s assets in achieving their target allocations.
Rebalancing is not the same as dollar-cost averaging. Only the deposited dollars are exchanged during a dollar cost averaging event. The whole pоrtfоliо may or may not achieve its targeted allосatiоns. It’s possible that the pоrtfоliо has gotten so far away from the target areas that a dollar cost average won’t get you there.
LOWER TRADE FREQUENCY
Traders that are aware of the number of transactions they make have found a method to reduce the frequency with which they execute their deals. This might reduce the number of taxable transactions, eliminate the need for some rebalancing, and maintain the portfolio balanced when additional funds are needed.
If you make regular contributions, it could be possible to replace some rebalancing with dollar-cost averaging events. This can save you money on rebalancing costs, minimize the amount of money you transfer back and forth between the same assets, and help you develop a more holistic portfolio.
DcA, like the majority of the solutions we cover, is an additional tool to make your life simpler. There’s no need to fiddle with manual trading, threshold rebalancing, or manually trading to replicate DcA. Simply specify your DcA, and when you make a deposit, your cash will be automatically allocated.