The Best Strategy to Invest: DCA vs Lump Sum Investing

Dollar Cost Averaging
After saving up a sum of money, be it $100, $1,000 or $10,000, as a beginner investor, we’re always faced with a daunting question:
“When is the right time to enter the market?”

I won’t lie, I faced this very same question with my first stock purchase as well. I wanted to buy in at the lowest possible point and to see only profits from my purchase onwards. I watched the stock price bounce up and down, deep down praying it dipped quickly so that I could buy in. Of course, as everyone knows no one can time the market perfectly and after buying a bunch of shares thinking that I got in at a great price, the share price continued to dip over the next week.

Well, how can we avoid this from happening to us?

Dollar Cost Averaging, of course, it’s the post title after all!

What is Dollar Cost Averaging?

Dollar Cost Averaging is an investment strategy in which the investor invests his or her money at regular intervals into the same stock, regardless of the price of the stock at the point of investing.

“Regardless of the price of the stock? You must be mad!”

Chotto matte! Let us take a look at an example then. Take a fresh grad, Clement, who has just started working and is looking for ways to invest a sum of USD 10,000 that he has saved up because he knows that he should make his money work hard for him. Clement chooses to invest in VOO because he read the post on Index Investing. Clement then  has 2 options:

  1. Put it all in in one shot (Lump Sum Investing)
  2. Invest it over time (Dollar Cost Averaging)
Date Price of VOO (USD) No. of Shares Bought (Lump Sum) No. of Shares Bought (DCA)
1/1/2020
279.29
33
8
1/3/2020
274.00
0
9
1/5/2020
262.14
0
9
1/7/2020
284.37
0
8

The column on the left represents Option 1: Lump Sum Investing, while Option 2: Dollar Cost Averaging  is represented by the second column on the right. Evaluating Clement’s investment returns after 1 month from the last entry (i.e. on 1/8/2020), when the price of VOO is USD 301.99:

Option Lump Sum investing Dollar Cost Averaging
No. of Shares
33
34
Average Cost
USD 297.29
USD 278.78
Total Amount Invested *
USD 9,810.57
USD 9,458.54
Final Market Value of Investments
USD 9,955.44
USD 10,257.12
Returns
1.4767%
8.4430%
*Note that the initial invested amount differs as we are purchasing whole shares only

Evidently, Dollar Cost Averaging has allowed Clement to lower his average cost lower than if he had put it all in in January, hence netting a higher return on investment as compared to Lump Sum Investing.

Benefits of Dollar Cost Averaging

Reduces the Impact of Volatility

From the earlier example, Clement invested through the March crash and into the rally following allowing him to reduce the impact of the crash on his investments and consequently benefiting from the quick turnaround in the stock market.

Dollar Cost Averaging certainly does not necessarily allow us to buy in at the lowest point or avoid buying at the peak, but it does leave us with an average price that is pretty decent.

Removes Emotions from Investing

Dollar Cost Averaging takes out the emotions from investing. This is because the entry is not dependent on the stock price and how we feel about the stock price on that particular day. It allows us to buy even when we think the stock price will continue falling.

This is especially important during market crashes where we might try to catch the bottom and in prolonged bull markets where we might try to predict the “inevitable crash” (and likely fail haha).

This prevents us from encountering what Singaporean investors like to refer to as “missing the boat”. I remembered during the market crash in March 2020, many people thought the rebound would be short lived and the markets would continue to tumble similar to 2008’s crash. Alas, the market has yet to hit a new low and they have “missed the boat”. If they had instead chosen to Dollar Cost Average, they would have made it out with some pretty nifty returns considering the tremendous 60% rise from the March lows since then.

S&P 500 performance from March to Dec 2020
S&P 500 Performance from March Lows to Dec 2020

In fact, missing out on just the 10 best days in the stock market for each decade since 1930 net investors only 91% since then while investors who didn’t gained over 14,900% over the same period!

Drawbacks of Dollar Cost Averaging

Lump Sum vs Dollar Cost Averaging

With all that said and done, there are still drawbacks to Dollar Cost Averaging.

One main drawback would be that Lump Sum Investing (investing it all in one go) was actually shown to beat Dollar Cost Averaging 66% of the time in a 2012 study done by Vanguard. In fact, over longer time frames, this percentage increases.

Why is this the case?

Well, if we took an absurd example, where we had $100,000 but only added $1,000 to our investments every year, the amount we kept to side would be missing out on the returns in the market.

Logically, this should be true on a smaller time frame as well, meaning that Lump Sum investing would generally beat Dollar Cost Averaging, where Dollar Cost Averaging usually only outperforms Lump Sum investing during market crashes.

Dollar Cost Averaging Requires Discipline

Dollar Cost Averaging may be simple in concept, but it is not easy to execute. It requires you to be disciplined with the money that you have on the sidelines between the intervals when you invest more. If you’re not disciplined, you may accidentally spend it on the latest gaming console or a new pair of shoes.

Moreover, there’s always the risk of your own emotions getting in the way when it’s time to put the money in. It’s normal to have the lingering thought at the back of your mind, telling you that the market is close to all time highs and that it is going to crash soon.

Dollar Cost Averaging Incurs More Commissions

It must of course, also be noted that Dollar Cost Averaging incurs larger commissions too as compared to Lump Sum Investing. This is because you will generally be making more transactions when Dollar Cost Averaging. This may eat into your returns as a result.

Well, So What Should You Do?

At the end of the day, I think for most beginners, it is easier (on the heart) to start with Dollar Cost Averaging. When we start out, it is normal to have the fear that we are investing at the peak right before a massive crash. Dollar Cost Averaging allows you to slowly build up confidence in investing by starting with a small amount and allows you to familiarise yourself with the market. 

Over time, as you become more sure of yourself in navigating the markets, you can then add Lump Sum Investing into your skillset as well to become a more rounded and competent investor for the future.

Photo by Lorenzo from Pexels

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