WHAT IS DCA
Investors utilise dollar cost averaging (DCA) to lessen the downside risk of putting big quantities of money into the market at once.
While this can take the shape of buying a single asset on a regular basis, we’ll be looking at the technique from the standpoint of a portfolio. Consider it as a means to add fresh funds to a portfolio on a regular basis.
A dollar-cost averaging technique will effectively disperse the injected money across portfolio management based on a predetermined list of target allocations.
HOW IT WORKS
Let’s break down each of the phases that take place during a dollar-cost averaging event to better comprehend this method.
DETECTION OF DEPOSITE
Only when a deposit is discovered would DCA run. We may check if new funds have been added to the portfolio on a regular 15-minute frequency. A DCA is triggered when a deposit is identified.
We shall record the amount of the asset that was deposited at the moment of deposit detection. In the next phases, the DCA will only utilise these deposited money to conduct trades.
We’ll take the monies that were deposited and figure out how to distribute them for the dollar-cost averaging technique now that the deposit has been noticed. During the DCA’s execution, no additional assets or monies will be transferred.
We can determine how much of the deposited funds should go to each of the assets in the portfolio to attain our goal allocations based on the present allocations of our portfolio and the matching target allocations.
EXECUTION OF TRADE
Each individual transaction will be conducted to establish the target portfolio after the desired trades have been determined. Any monies remaining at the conclusion of the DCA as a result of unsuccessful trades or minimum trade limitations will be placed in the deposited asset.
Let’s take a look at a portfolio simulation as an example of how DCA works.
Assume we have a $100 investment portfolio. This portfolio now has an even distribution of five distinct assets, each of which has a value of $20. As a result, we may argue that the portfolio presently has 5 assets allocated at 20% each.
HOW IT IS USEFUL
Dollar-cost averaging is a portfolio approach that allows money to be detected and distributed quickly. The funds are dispersed in such a way that they help the portfolio’s assets attain their target allocations.
Dollar-cost averaging is not the same as rebalancing. During a dollar cost averaging event, just the monies that were deposited are exchanged. The portfolio as a whole may or may not attain its desired allocations. It’s possible that the portfolio has strayed far enough from the target allocations that a dollar cost average won’t bring you there.
REDUCE TRADE FREQUENCY
Traders that are cognizant of the amount of transactions they make have devised an approach to limit the frequency with which their trades are executed. This may minimize the number of taxable transaction events, remove the need for some rebalancing events, and keep the portfolio balanced during times when additional funds are deposited.
FEES OF TRADING
It may be able to replace certain rebalances with dollar-cost averaging events if you make frequent contributions. This can help you save money on rebalancing costs, limit the amount of money you transfer back and forth between the same assets, and build a more holistic portfolio plan.
DCA, like most of the solutions we cover, is another approach to make your life easier. There’s no need to mess around with manual trading, threshold rebalances, or manually trading to replicate DCA. Simply set your DCA and your cash will be automatically allocated when you make a deposit.