We have now compared Lump Sum versus Dollar Cost Averaging (DCA) investing. Lump Sum may outperform in long run returns. DCA may prove better for “smaller” investors and in dealing with shorter term market volatility. DCA may promote investor consistency and discipline. DCA may also help create well-diversified, high-quality investment portfolios.
A few final thoughts on the Lump Sum versus DCA investing debate in Episode 51 on the Wilson Wealth Management YouTube Channel.
“Does Lump Sum investing provide superior long-term growth?”
Yes. With a few caveats.
Studies tend to assume that Lump Sum investors have cash readily available to invest on day one. In reality, most investors do not have funds to invest up front. It may take time to accumulate cash to make the lump sum investment. And that needs to be factored into the calculations. Often, it is not.
In the long run, assets appreciate. But in the short to medium terms, you will face significant volatility. When you invest and your holding period can greatly impact portfolio returns.
For more detail on the advantages of Lump Sum, please refer to “Episode 44: Lump Sum Investing”.
“How can DCA assist is dealing with short to mid-term volatility?”
If you possess strong market timing skills, then Lump Sum is great to take advantage of price swings.
Unfortunately, even the professional asset managers are not very good at timing market movements.
DCA does help smooth out price volatility in your portfolio. Because you are investing a fixed amount each period.
Investing $1000 every 4 months? On January 1, the investment trades at $10. You are able to purchase 100 shares. On May 1, the asset trades at $20. Your $1000 only buys 50 shares. On September 1, the asset trades at $4 and you buy 250 shares. At December 31, you own 400 at an average cost of $7.50. A lower adjusted cost base than if you had invested the $3000 at $10 per share on January 1 and received 300 shares.
Of course, if there was no volatility, only straight growth from $10 to 15, DCA would underperform.
And yes, there may have been dividends missed that also impact total return. And the additional transaction costs. So there are other factors to consider when comparing.
For more on this, please refer to “Episode 45: DCA: Market Volatility”.
“How does DCA help ‘smaller’ investors?”
Most investors do not have cash sitting around, waiting to be invested. Lump Sum investing, while perhaps providing better performance, may not be practical for the average investor.
If it takes 6-12 months to save before making a Lump Sum purchase, that negates some of the outperformance versus DCA.
For more detail, please refer to “Episode 46: DCA: ‘Smaller’ Investors”.
“How can I improve investing consistency and discipline by using DCA?”
Consistency and discipline go hand in hand.
Consistency is more about the actual process. If you set up a system where you automatically invest $300 per month, that is consistent.
It also has a behavioral finance aspect. Like a phone bill or Netflix account, you adjust to having $300 less disposable income every month. In short order, you “forget” about your investing funding. Compare with having to find $3600 on January 1 for a lump sum investment. A bit different on the mindset.
For more on consistency, please refer to “Episode 47: DCA: Consistency”.
Discipline, to me, is more the emotional side of consistency. Markets are up. Will they fall? Should I buy into a bull market? Especially if “television talking heads” are warning of a correction. Markets are down. Should I buy when everyone else seems to be selling? Maybe I should wait until the bottom is reached and things are picking up again.
As opposed to just investing that $300 per month and not worrying about the short term ups and downs. A smarter way to build a portfolio. And definitely helps with emotional discipline when your stomach (and the “talking heads”) are creating uncertainty in your actions.
For more on discipline, please refer to “Episode 48: DCA: Discipline”.
“How can DCA help better diversify my portfolio?”
You can effectively diversify a portfolio under Lump Sum.
But it is something that works very well with DCA. Especially for smaller investors.
Mutual funds are usually set up for small investors, making periodic investments of relatively low amounts. You also can receive partial units in a fund, allowing you to invest all your capital immediately.
While not the same process with Exchange Traded Funds (ETFs), often pricing of ETFs is such that buying shares is not an issue. You tend not to see ETFs priced like Google (USD 2526 at June 28, 2021) or Amazon (USD 3430). Instead for diversified ETFs, prices are more reasonable. If we look at iShares, we see the Dow 30 (IYY at USD 108), S&P 500 (IVV at USD 428), rest of developed world in EAFE (EFA at USD 80), or Emerging Markets (EEM at USD 55).
We also see that ETFS and mutual funds offer almost every possible investable market. Small cap or mega? Value or growth? Specific sectors? Individual countries? And so on. Usually at reasonable share prices for all investor levels.
For more on diversification, please refer to “Episode 49: DCA: Diversification”.
“Finally, how can DCA help improve my portfolio quality?”
Investing in “quality” assets is actually more difficult than it seems.
If professional money managers could consistently pick the winners, they would easily outperform their benchmark indices. Which hold both the good and bad assets. And, as we have discussed, there are reasons why outperforming is hard.
A DCA strategy works best in a passive approach. Investing in index funds. For most indices, there are minimum requirements to be included.
For example, the S&P 500 is essentially the largest 500 companies traded on the NYSE or NASDAQ. Essentially, as there are some other criteria, including positive earnings over time. As once-dominant companies weaken, they are replaced on the index with up and comers.
In 1999, long-term dominant companies Goodyear Tire, Sears & Roebuck, and Chevron all left the Dow 30. Replaced by Microsoft, Intel, and Home Depot. In 2015, AT&T, a Dow component since 1916 departed. In its place, Apple. And so on.
Also, indices like the Morningstar Dividend Yield Focus Index rely on screening criteria for index inclusion. In this case, Morningstar takes its US Market Index components (97% of US equity market stocks) and screens them for the top 75 dividend producers. Criteria reflect financial health and dividend related areas. As it is only 75 holdings, it is easy for the bottom tier to vanish and new stocks to enter over time.
While you may only hold the single index, there will be turnover of the underlying assets.
For more on quality, please refer to “Episode 50: DCA: Quality”.
