Why Dollar Cost Averaging Is the Way To Go (for Most People)

Dollar cost averaging (DCA) has to be one of the most commonly thrown about terms when it comes to investing. Let’s talk about how it works, why it works (or not), and why it doesn’t really matter whether it works.

A primer to DCA

DCA means investing a fixed amount of money each month, as opposed to putting a lump sum all at once. This reduces the risk of buying at the wrong time as your investment is spread across time.

Let’s assume the following example of a hypothetical fund:

MonthUnit PriceInvested AmountUnits Bought
April$1.00$500500
May$0.92$500543
June$0.87$500575
July$0.89$500562
August$0.92$500543
September$0.93$500538
Total$0.92 average$3,0003,261 ($3,033)

As one would expect from investments, prices tend fluctuate and be volatile in the short term. Here, DCA manages some of the volatility. A $3,000 investment in the month of April would buy 3,000 units, which would be $2,790 in September. A DCA strategy, on the other hand, buys more units as the prices slip, and even when the price does not recover to its original level in April, there is a small profit made.

MonthUnit PriceInvested AmountUnits Bought
June$0.87$3,0003,448
In September$0.933,448 ($3,207)

If an investor had plopped all $3,000 in the lows of June, he would have made more money than the person who DCA.

Seth has a deal
Seth has a deal

Get a $5 e-voucher to spend at JEM, PLQ, 313 Somerset, and Parkway Parade when you download the Lendlease Plus app and use referral code odXoC9. It takes all of two minutes and keeps this site going. Thanks!

Does DCA work?

Whether or not DCA works depends on what you are referring to. Studies have shown that lump sum investing actually outperforms DCA roughly two thirds of the time. We can’t tell the future, generally speaking, and we wouldn’t really know whether we should buy in April, or in June, but the statistical odds are better if we just invested lump sum rather than splitting it up into smaller transactions over time.

Why then do I say that it is the way to go for most people?

The fact is that most people don’t have lump sums of money to invest to begin with, and have to invest monthly anyway. It’s not really DCA as much as it is as “I only have this much to start”.

Another reason is that investing monthly in an automated way is really quite magical. You can certainly invest on an adhoc, lump sum basis if you have the acumen and discipline, but most people are better served by investing automagically. Years ago I decided to set aside $500 per month for a particular index fund and it has now grown to more $20,000. Would I have dutifully put that money into investments? I doubt so.

Whatever gets you investing

Even if you do have a lump sum to invest right now, it can be unnerving putting in a sizeable amount of money at once. It is more palatable to most people to split the sum and invest it over time, and that is surely better than not investing at all. Lump sum investors often try to time the market, and might end up delaying their investments. Again, I speak from experience: I had a “war chest” to deploy when markets came down, only to watch markets repeatedly hit new highs. I eventually used the money for the downpayment of my apartment… months before March 2020’s market correction 🙃

If I had a lump sum now, what would I do? A half measure seems appropriate: I’ll probably invest a third to half of it in a lump sum, followed by DCA the remaining over a year or so.

Conclusion

Pros

  • Start from low amounts
  • Reduces psychological barriers against investing
  • Automatic way builds habit and wealth over time

Cons

  • Statistically less returns than lump sum investing
  • Tends to incur higher transaction fees

One pitfall of DCA is that transaction fees tend to be higher as a result of smaller transactions, and that eats up your returns. On a $10,000 transaction, $25 may be a relatively small 0.25% fee to pay, but it is an exorbitant 2.5% charge on a $1,000 investment.

To overcome this, you may consider roboadvisers like Syfe, or low-cost trading platforms like moomoo. Do note that I may earn affiliate fees when you sign up for products on this site, so you should also explore other roboadvisers or platforms that may suit your requirements more. Stay subscribed as I explore more tools and products that would prove useful in your financial journey.

Keep up to date on the best cashback/mile cards, savings accounts, attractive deals, and more tips to maximise your financial wellbeing by subscribing to my Telegram channel.

Subscribe to the channel, then join the group chat. You would often benefit from the tips exclusively shared in the group chat!

Leave a Reply

%d bloggers like this: