Dollar Cost Averaging Revisited

In an earlier article I looked at the level of risk, defined as volatility, associated with investing in crypto compared to more conventional investments such as equities and bonds.

In this follow-up article I want to look at Dollar Cost Averaging (DCA) as a suitable investment strategy for more volatile assets. This is the approach @hitmeasap favours in his post How often should you buy and sell crypto.

Let’s back up a little and look at what an investment strategy actually is.

What Is An Investment Strategy?

According to everyone’s favourite go-to source for all things investments, Investopedia, the term investment strategy

“…refers to a set of principles designed to help an individual investor achieve their financial and investment goals. This plan is what guides an investor's decisions based on goals, risk tolerance, and future needs for capital.”

I have not figured out why this term should be limited to “individual investors” because institutional investors should definitely have a “game plan” for putting their investors’ money to good use. Certainly, if they want to be successful longer term!

In any case, the definition shows that simply using DCA to buy crypto appears insufficient to qualify as a “strategy”.

Investment Strategy Categories

As far as a broad brush approach to investment strategies is concerned, we can go with 5 distinct categories:

• Growth investors buy assets that are rapidly expanding.
• Momentum investors buy assets that have already risen in price on the expectation that they will continue to appreciate in price.
• Contrarian investors look at what the crowd is doing and play devil’s advocate by taking the other side of that trade. It is often confused with value investing which often appears to have a similar investment logic.
• Value investors buy assets that have been overlooked and ignored by others in the investing community.
• Income investors focus on the income a particular asset can derive. This is often regarded as a low risk strategy as the focus is on receiving a regular stream of income rather than generate capital gains.

Most investments in crypto qualify as momentum plays. FOMO is the over-riding sentiment when things heat up. And despair sets in when prices plummet. During either of these periods it is quite a difficult task to stick to your chosen investment strategy.

What I wanted to do in this article is compare the performance of several simple DCA strategies for the assets of my previous article. The assets are:

• BTC
• the NASDAQ Composite represented by the ONEQ Exchange Traded Fund (ETF)
• the Russell 2000 Index represented by the IWM ETF,
• the 10-Year US Treasuries represented by the IEF ETF,
• Apple shares, and
• Tesla shares.

Before employing any investment strategy, it is sensible to assess whether the strategy actually works. That means you evaluate whether your investment strategy was profitable in the past.

There is obviously no guarantee that the same investment strategy will continue to work in the future. However, if it has worked in the past, you have some comfort that following your investment criteria will give you a positive result.

The Assumptions

The assumptions in my back-test are the following:

• This is a long-only strategy. The strategy will only buy the underlying asset and hold it. There are no sales of the asset. Nor are there any short sales.
• The strategy is concerned with accumulating assets over the long term. There is no trading.
• The investment is made monthly on the first trading day of every calendar month.
• The investment amount is USD100 every month.
• The assets are bought at the designated “Close” price of the day.
• I have assumed no trading costs.
• I have assumed that the assets do not generate income. In the case of the equity investments shown this is not realistic as all of the assets pay dividends. This is for simplicity.
• I have made the unrealistic assumption that you can buy fractional shares. In real life you cannot buy half a share of Apple.
• The start date of my back test is 1 January 2015. The end date of my back test is 3 June 2022. This means a total investment period of 90 months and a maximum investment of USD9,000.

I will show a total of 5 different DCA investment strategies. They are:

• A simple monthly investment of USD100 per month.
• An investment of USD100 every month when the price of the underlying closes below the 50-day Simple Moving Average (SMA). This is a simple medium term value strategy.
• An investment of USD100 every month when the price of the underlying closes above the 50-day SMA. This is a medium term momentum strategy.
• An investment of USD100 every month when the price of the underlying closes below the 200-day SMA. This is a longer term value strategy.
• An investment of USD100 every month when the price of the underlying closes above the 200-day SMA. This is a longer term momentum strategy.

Investment Performance

Let’s have a look at the results, starting with our simple monthly investing strategy.

It is obvious that BTC outperformed all other assets over the time period.
What is interesting is that the supposedly safest asset, the ETF investing in 10-Year US Treasuries lost money (again this excludes dividend payments!) over the last 7 ½ years. So much for conventional investment wisdom!

Let’s have a look at our first investment strategy employing a simple filter, in this case the 50-day Simple Moving Average (SMA). Using this strategy, we only buy the underlying asset if on the first trading day of the month it is trading below the 50-day SMA. If the price is trading above it, we will not invest.

The results are as follows:

What is interesting here is that the investment performance of all assets has improved. The exception is BTC, albeit marginal. In addition, we also have less money at risk.

Our second investment strategy looks at a medium term momentum strategy. In this case we only buy the underlying asset if the asset is trading above the 50-Day SMA.

Here are the results:

This appears to be an investment strategy that does not improve the overall performance. The investment performance is worse than the simple monthly investing approach as well as our medium term value strategy.

Our third investment strategy is a longer term value strategy. Here we only buy the underlying asset if the price closes below the 200-Day SMA.

The results are shown below:

Using a longer term value approach does not appear to favour BTC at all. Although the actual performance still puts most traditional assets to shame, compared to the earlier strategies it reduces the performance by half.

This strategy does, however, improve the performance of the traditional investments, with the exception of the NASDAQ Composite ETF which underperforms its best strategy by about 7 percentage points. The 10-Year Treasuries still lose money though.

Our last investment strategy looks at a longer term momentum approach by only investing if the underlying asset price closes above the 200-Day SMA.

The results are shown below:

The only asset that benefits from this strategy is BTC. None of the others perform as well as when we use a more value-based approach.

How Do We Interpret The Results?

The back test clearly shows that employing a disciplined investment strategy over the longer term will generate solid returns. Irrespective of the underlying asset, unless it was a fixed income asset. The simple monthly investment of USD100 over the last 7 ½ worked for 5 out of the 6 assets.

You can improve the investment performance for some assets by adding a simple filter. For equities this simple filter tends to be the 200-Day SMA.

For a high growth asset like BTC, and possibly most other worthwhile cryptocurrencies, using a filter does not appear to improve results. Hence, a long term accumulation strategy such as a monthly investment plan looks to be a viable approach that bridges the inherent volatility of the asset.

All it requires is the discipline to put an affordable amount to use every month. And not be ruled by FUD in times of trouble. Or FOMO when things take off.

To answer @hitmeasap's question as to how often you should buy crypto my answer would be to buy a little every month. Then stay the course. And look at the longer term.

As to addressing how often you should sell crypto, we will leave that for another article!