A potential advantage of Dollar Cost Averaging (DCA) versus Lump Sum investing is that it may benefit “smaller” investors. That is, individuals without extensive investment portfolios nor having excess cash on hand to invest 100% on day 1. While Lump Sum may theoretically provide better performance, the reality is that investors tend not to be able to invest everything up front.
All that and more in Episode 46 on the Wilson Wealth Management YouTube channel.
“Who are ‘smaller’ investors?”
Probably you. Probably most of us.
You are talking to your local golf pro and she mentions a great stock to invest in. Do you have $5000 or $10,000 sitting in your bank account to immediately purchase shares?
Or, is your investment portfolio of sufficient size and diversity that you can quickly sell one of your underperforming holdings to invest in this new opportunity?
If the answers are “not really”, you are a smaller investor.
If I look at the RRSP bank-loan business in February each year, very few investors have excess cash available for purchasing new investments. Small investors are the norm, not the exception.
“So Lump Sum may not be practical for most investors?”
Yes. At least in the way most studies compare Lump Sum to DCA.
Studies tend to compare buying 100% of an asset on (say) January 1, 2018 versus buying in equal portions over (say) 24 months. Maybe that is $12,000 up front versus $2000 very second month for two years. In those studies Lump Sum tends to win out.
However, most investors do not have $12,000 sitting there just waiting to be invested. If you need to save for 6-9 months before being able to invest, you should factor that into the calculations.
There is also the opportunity cost in what you did with your finances during that two year period. Did you borrow to be able to buy 100% on day 1? Did you forgo other opportunities or incur other costs, just to have the $12,000 available? What about the lost return on any assets you liquidated to invest?
Might it have been better on your life to invest $1000 per month or $2000 bi-monthly over two years?
“How does DCA and behavioural finance impact the ‘smaller’ investor?”
We will also discuss this in future episodes. As DCA is very much related to investor behaviour.
DCA promotes good investing practice, especially for investors with limited capital. If investors use DCA, they may begin to make automatic deposits on periodic bases. If you consistently invest $200 a month, you may feel the financial pain for a month or three. But then it becomes like your internet, cell phone, rent, etc. You adjust in other lifestyle areas and do not notice the deductions.
Investing becomes more of a painless process. Rather than scrambling to find lump sums to invest.
“Can I actually invest with $200 per month?”
Maybe. Maybe not. It depends on the investments.
DCA is well suited to passive investing. If you buy index mutual funds, you should not pay transaction costs. And most fund companies allow for subsequent purchases in very low dollar amounts. Perhaps $500 or $1000 minimum on the initial investment, with subsequent investments as low as $50 or $100.
If you purchase exchange traded funds (ETFs), they may have lower annual costs than mutual funds. Not always. But often. However, you will pay a (say) $9.99 broker transaction fee on every purchase. If you are investing $100 at a time, you do not want to pay $10 in broker fees.
To reduce costs, you can store your periodic deposits in your investment account. Then purchase when you have a critical mass. Or, there may be so-called “no-transaction fee” ETFs available from your online broker. That eliminates the fee to buy or sell. Though, there are potential pitfalls with these “no-transaction fee” offerings.
For a little more on the pros and cons of “no-transaction fee” ETFs, please review “Episode 41: ETF versus Mutual Funds”.
For more information on this overall topic, please read “Investors and Dollar Cost Averaging”. We will also discuss how DCA promotes investing consistency, discipline, diversity, and quality, in the coming episodes. Topics that are crucial for any investor, but especially those with limited capital.
