Another potential advantage of Dollar Cost Averaging (DCA) versus Lump Sum investing is consistency. DCA helps investors promote a more consistent investment approach. Crucial for long-term investment success. But a characteristic lacking in too many investor philosophies and strategies.
All that and more in Episode 47 on the Wilson Wealth Management YouTube channel.
“Does that mean that all Lump Sum investors are inconsistent?”
No. Although there is a higher probability of inconsistent investing under Lump Sum.
With Lump Sum, there are three approaches.
You already have cash on hand. You review different investment options and invest 100% on day 1.
You need to accumulate cash over 3, 6, 9 months. Once you reach a critical mass, you research investments, and then invest 100% at that point.
You have identified an investment you wish to purchase. You then accumulate cash over time and invest 100% when you reach a critical mass.
The first option is best, though most investors do not have excess cash sitting there to invest. Option two is more common. You decide to invest, start saving, then find the “best” investment when you have saved enough cash. Option three is also common. The problem is that if it takes 12 months to amass capital, is it still the “best” investment a year out? Investors should do another review before buying.
Now, yes, investors using these strategies can be consistent. But life often gets in the way. As they are saving to invest, maybe the car breaks down. It is a cold winter and that $3000 you have already saved can help pay for a Hawaiian vacation.
Now compare that with simply setting aside $200 per month and investing every month or two.
In the real world, which approach will prove more consistent for most individuals over time?
“Can you explain more about behavioural investing and DCA?”
Part of investor behaviour is discussed above. Will investors have the will-power to save and consistently make Lump Sum purchases?
On the other side, DCA should become more like your utilities or cable bill. It is just another monthly expense that you adjust to over time. Hopefully, one that becomes painless in a year.
The amount contributed can be relatively low in your early years. But increase as disposable income rises. Again, DCA takes away human behaviour and promotes consistency.
“DCA really seems like a “no-brainer” approach to easily build wealth. Is it?”
Easy, yes. A “no-brainer”, not quite.
That is a problem for some DCA investors. They just set up an investing program, contribute on a consistent basis, and forget about it until maturity.
Even investing in well-diversified, low-cost, index funds requires continuing maintenance. Over time, your overall asset allocation will be out of sync with your planned target allocation. Depending on your personal circumstances, your target asset allocation may need adjustment.
Perhaps that “best in class” fund that you researched and started investing in 10 years ago is no longer high quality. New, improved products always come along that bear comparing. Maybe your wealth has increased and you should add other complementary products to your original portfolio foundation.
And so on.
Yes, DCA is useful and promotes a consistent investment approach. But there is more to the investment process than just ongoing funding. We will cover portfolio reviews and rebalancing in future episodes.
If you would like to read more on this subject, please check out “Dollar Cost Averaging: Consistency”.
