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What is the cost-average effect?

Do you want to invest regularly in cryptocurrencies without needing to time the market? The cost average effect, also known as the pound-cost averaging strategy, can help reduce the impact of price fluctuations over time and support more consistent investing. This strategy is commonly used in volatile markets like crypto or in long-term savings plans. In this article, you'll learn what the cost average effect is and how to calculate it. This approach can help you invest your money efficiently in the long run and smooth out market volatility. We’ll also explain the advantages and disadvantages of this method and compare it to lump sum investing, so you can better understand which approach might suit your financial goals.

The cost average effect, also referred to as pound-cost-averaging (DCA), is an investment strategy where a fixed amount is invested regularly to smooth out price fluctuations and the average purchase price.

This strategy is particularly useful in volatile markets, such as cryptocurrencies, as it can reduce the risk of buying at high prices by purchasing more units when prices are low and fewer when prices are high.
However, a lump sum investment can be more beneficial in strongly growing markets, as the capital benefits immediately from potential price increases.
DCA is ideal for long-term investors who prefer to avoid market timing risks, while lump sum investing may suit those who believe in rising markets and want to generate returns more quickly.

Simply explained: What is the cost-average effect?

The cost-average effect, also known as the average cost effect, describes an investment strategy where a fixed amount is invested regularly over a certain period. This is particularly common in savings plans. By investing regularly, you acquire crypto at an average entry price.

Why is the cost-average effect sometimes called a "myth"?

The cost-average effect is sometimes referred to as a myth because it is seen as a method to reduce the risk of market fluctuations. However, the average cost effect has no positive impact on returns. The success of this effect depends on market developments and can be advantageous or less effective. In consistently rising markets, a lump-sum investment could prove more profitable in hindsight, as you would have fully benefited from price gains right away. The success of the cost-average effect depends on market conditions and the long-term performance of the chosen investment.

How does the cost-average effect arise?

Simply put, the cost-average effect occurs when a fixed amount is regularly invested in a volatile asset such as cryptocurrencies. This can lead to a lower average purchase price and help balance out price fluctuations.

Example: Calculating the cost-average effect

Understanding the cost-average effect is easiest with an example. Imagine you invest £100 per month in Bitcoin.

The impact of the cost-average effect in comparison:

Month 1: Bitcoin price £ 30,000 – You receive 0.003333 BTC (£ 100 / £ 30,000)
Month 2: Bitcoin price £ 51,000 – You receive 0.001961 BTC (£ 100 / £ 51,000)

After two months, you've invested £ 200 and accumulated 0.005294 BTC. Your average purchase price per Bitcoin is approximately £ 37,800 (£ 200 / 0.005294 BTC), which is about 26% lower than the higher price in the second month.

Since Bitcoin is a highly volatile asset, price fluctuations are significant. You can see that the cost-average effect is particularly noticeable here. With the Bitpanda Savings Plan, you can apply the cost-average effect by setting up regular cryptoasset purchases in a simple, automated way. With weekly, bi-weekly or monthly purchases, you are less dependent on short-term price fluctuations and may benefit of cost-averaging over time.

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How can I use the cost-average effect?

You can use the cost-average effect by regularly investing a fixed amount in a cryptoasset. This method can help reduce the risk of high entry costs and balance out price fluctuations by achieving a more favourable average purchase price over time.

By automatically investing at regular intervals, you achieve an average purchase price over time, which helps smooth out price fluctuations. This allows you to focus on your long-term investment strategy without being influenced by short-term market conditions, making it especially suitable for investors with limited time.

Checklist: When is the cost-average effect useful?

The cost-average effect is particularly useful if you want to invest regularly and over the long term to balance out price fluctuations. It is well suited for volatile markets and for those who prefer to invest smaller amounts regularly.

To determine whether the cost-average effect aligns with your investment strategy, you can use the following checklist:

Long-term investment goals: You plan to invest over a long period (several years).
Regular investment amounts: You can consistently invest fixed amounts, e.g. monthly.
Risk diversification: You want to reduce the risk of high entry costs and mitigate the impact of price fluctuations.
Avoiding market timing: You prefer a strategy that does not rely on finding the perfect entry point.
Volatile markets: You invest in markets or assets subject to significant price fluctuations, such as cryptocurrencies or stocks.

Conclusion: Who benefits from the cost-average effect?

The cost-average effect is ideal for investors who want to invest regularly and for the long term without being overly affected by price fluctuations. This strategy offers advantages for both beginners and experienced investors looking to build their investments over time and reduce the risk of high entry costs. However, those seeking short-term gains or primarily investing in stable markets may benefit more from other investment strategies.

Here's an overview of investor types who can benefit from the cost-average effect:

Beginners: The cost-average effect does not require in-depth knowledge of market timing, making it ideal for those new to crypto.
Long-term investors: Those with a long-term investment horizon can benefit from an optimised average price, especially in volatile markets.
Savers with a limited budget: Regularly investing smaller amounts allows wealth accumulation without the risk of committing a large lump sum at once.

Investors in volatile markets: For assets with high volatility, such as cryptocurrencies, the cost-average effect helps reduce price risks and achieve a more stable average purchase price.