Lump Sum or Dollar Cost Averaging… Which works better?

With regard to investment, u probably have asked yourself the question above…

The answer:- it depends 🙂

When we invest, there are 3 possible outcomes:-

a) market goes up

b) market goes sideways

c) market goes down.

For lump sum investment, we make profit if (a) occurs. On the other hand, (b) and (c) are not uncommon as illustrated in the following diagrams:-

Periods when S&P Index (US) was trading sideways

Lump Sum or Dollar Cost Averaging... Which works better? — Engage

Magnitude & Frequency of Market Drawdown

Lump Sum or Dollar Cost Averaging... Which works better? — Engage

Let me now define dollar cost averaging.

Dollar Cost Averaging (“DCA”) involves investing a fixed dollar amount at regular intervals (monthly/quarterly etc) over a period of time. By setting aside a fixed amount consistently, it allows you to manage your emotion while taking advantage of market volatility to buy more during a market correction.

My Investment Director recently did an analysis on DCA, assuming certain scenarios, using the following parameters:-

a) a fixed amount of $1,000 is invested monthly;

b) a period of 49 months; and

c) a sideway market (market starts and ends at the same level) as well as a down market

1st scenario: Market Goes Up and Down a Lot (Up +120%, Down -90%)

Lump Sum or Dollar Cost Averaging... Which works better? — Engage

2nd scenario: Market Goes Up and Down a bit (Up +30%, Down -30%)

Lump Sum or Dollar Cost Averaging... Which works better? — Engage

3rd scenario: Market goes down -48%

Lump Sum or Dollar Cost Averaging... Which works better? — Engage

So long there is volatility, DCA outperforms lump sum in a sideway market (prices starts and ends around the same price) or in a down market.

Reason why DCA outperforms in a sideway market

Lump Sum or Dollar Cost Averaging... Which works better? — Engage

The fact that more units are bought during the down leg allow faster compounding when the market recovers.

——————————————————————————————————————————————————————————–

Key Takeaways on DCA

a) Takes timing out of the equation (useful given the unpredictable nature of markets)

b) Helps to manage the emotional aspect of your investment journey (instead of looking at market corrections as a stressful period, we should now see such corrections as good opportunities to accumulate more units)

c) Ability to generate return in a sideway market

If you have any question on DCA strategy or connect with me.

Article is written by Thomas Ong Cheow Siang, Financial Advisory Manager.

Important: The information and opinions in this article are for general information purposes only. They should not be relied on as professional financial advice. Readers should seek independent financial advice that is customised to their specific financial objectives, situations & needs. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.

Published By:

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??Straight out of uni in the mid-1990s, I joined Prudential Assurance, wanting to have a career that connects with people and have flexible working hours. 

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