Are you better off spreading your investment capital over the long term, or making that lump sum investment today? Here’s a look at these two investment strategies and how they can work in sync.
Dollar-cost-averaging versus lump-sum investing is akin to paying for your big-ticket purchase upfront, or via instalments. There will be proponents for either option, with consumers selecting the one that best suits their needs.
There are perks of choosing either investment strategy. But there are also trade-offs. Ultimately, the investment method that suits you would depend on factors such as your risk appetite, investment goals and personal preference.
This article will look at these two types of investment strategies, their pros and cons, how you can execute it and who it’s for.
What is dollar-cost-averaging?
Go slow and steady. Dollar-cost-averaging is an investment strategy where you spread out your investments over the long term by making regular, recurring investments. These regular investments are typically made monthly or quarterly and this is exactly the concept behind regular savings plans (RSP).
Rather than investing a lump sum of $12,000 at the end of the year, you can consider DCA by investing $1,000 every month instead. Here’s an example of how DCA might pan out based on a monthly investment amount of $500.
|Monthly investment amount||Asset price||Number of units bought|
|Total||$3,000||$2.77 on average||1,112|
Over six months, you would have accumulated 1,112 units with $3,000 — better than the 833 units you would have gotten from investing all $3,000 in July. Although yes, you could argue it is not quite as good as the 1,428 you would have gotten if you had invested in November.
By making regular (and smaller) investments, you ensure that you continue to invest both during months when the market is high or low, averaging out the price you pay for the asset.
You can start a regular savings plan with just $100 monthly – a much less scary amount for rookie investors to start, that’s for sure!
There is also flexibility in this recurring investment. While the amount of money invested is fixed, automatic and recurring, you can still change the investment amount at your will.
Pros and cons of dollar-cost-averaging
|Pros of dollar-cost-averaging||Cons of dollar-cost-averaging|
|Avoid timing the market: Speculating the highs and lows of the market may cost you time, energy and of course, money||Slower portfolio growth: Potentially delays the entry of capital and you may miss out on the potential gains|
|Mitigate volatility and risk: You avoid putting all your eggs in one basket at the same time||Higher transaction costs: Each monthly investment accumulates transaction fees that could stack up|
|Start investing sooner, with less: $100 is enough to start on a RSP — far less daunting for a new investor||Returns lower than lump sum investing: Lump sum investing has shown to outperform DCA in the long run|
|Build your portfolio as you grow in confidence: Each investment is a small LEGO brick that adds towards a sizable portfolio|
|Instills discipline: Ensures that you regularly set aside and invest your savings|
How can you dollar-cost-average?
You can dollar-cost-average by starting a RSP with a provider such as your bank or other financial institutions. This allows you to make regular investments into asset classes such as stocks, exchange traded funds (ETFs), unit trusts and more.
Robo-advisors have also highlighted the merits of making regular investments, allowing customers to make regular, automatic deposits into their portfolios.
This can be done by setting up a standing instruction with your bank. Examples of robo-advisors that allow this include Autowealth, Stashaway and Syfe.
How frequent should these investments be?
Should you choose to make your regular investment weekly, monthly, quarterly or even annually? There is no right answer to how frequent this should be as it all boils down to your financial situation and investment goals.
Frequent investments allow you to capture all the highs and lows of the market. However, if you are investing a fraction of your salary, it could be more ideal for you to invest monthly, after you receive your salary. What’s more important is to ensure that you consistently invest regardless of market conditions.
What you can also do is to increase the amount you contribute to your portfolio whenever you can afford it, such as times when you get a pay raise or a bonus.
Who is dollar-cost-averaging for?
DCA is a great strategy for those who lack the discipline to invest, or those who would like to automate investments.
If you don’t have a large amount of capital to invest but would like to start growing your money, DCA could be a great strategy, especially if you are risk-averse. It could also be a good way for new investors to grow their portfolios while building the confidence and experience to make larger investments.
Who it’s not for: DCA might not be ideal if you already have the capital on hand to invest. Rather that spreading the cash out and earn low returns, you could instead invest it as a lump sum to reap higher returns.
Lump sum investing
What is lump sum investing?
On the opposite end of the spectrum, you’ve got lump sum investing – putting in a relatively large amount of money at one go. However, this lump sum differs from person to person. To a new investor, that could be $5,000. For an accredited investor, that could be upwards of $100,000.
The opportunities are aplenty with lump sum investing. You can use this capital to invest in an asset class of your choice: stocks, bonds, ETFs, Real Estate Investment Trusts (REITs), unit trusts, commodities, alternative investments and more. You can also deposit this lump sum into a portfolio with a robo-advisor.
Pros and cons of lump sum investing
|Pros of dollar-cost-averaging||Cons of dollar-cost-averaging|
|Higher long-term returns compared to DCA: Lump sum investing has been shown to outperform DCA most of the time||Higher risk in the short term: There is the possibility of investing before the market dips, thereby exposing yourself to short-term risks and losses|
|Longer horizon for your money to grow: Tap on the power of compounding and let time work its magic||Potentially less cash on hand: Don’t invest more than you can afford to, by ensuring that the capital does not come from your emergency funds|
|Reduce the opportunity cost of idle cash: Avoid leaving cash in low-yield instruments by investing it for higher returns|
How can you make lump sum investments?
If you’re using your capital to invest in the likes of stocks, ETFs and REITs, you can log in to your brokerage account and make the purchase directly when the market is open.
With robo-advisors, you have the option to deposit more funds or start a new portfolio. You can even opt to try out a different robo-advisor.
Who is lump sum investing for?
Lump sum investing is ideal for those looking to fast-track their portfolios to a sizable amount. Rather than spreading out the investment capital, you can channel it directly into your portfolio in order to reap higher returns.
This investment mode may be particularly viable for those who have a substantial amount of idle cash lying around, ready to ride the financial markets instead of cruising in low-yield instruments.
Investors who choose to invest with lump sums should be able to stomach relatively more risk as there is the possibility of a market dip in the near term.
Who it’s not for: If you are very risk-averse, you can spread your investments out with DCA instead. Investing a lump sum exposes your portfolio to relatively higher risk and volatility than DCA, especially if it makes up a large percentage of your entire portfolio.
Lastly, if you’re not exactly super cash rich, you can consider investing your funds at one go, rather than to spread an already small investment to an even smaller amount — your transaction costs could stack up.
Which is better: Dollar-cost averaging or lump sum investing?
If you’re focused on investment performance, investing a lump sum as soon as possible would derive higher returns over the long-term.
For example, investing a lump sum 10 years ago compared to DCA across the same period, would see higher returns. This is especially true as markets have historically proven to climb higher in the long run.
However, DCA remains a popular strategy as not everyone has the available capital to make a large investment today. Some might only have an extra $100 or two to spare each month. In such a scenario, an investor could be better off starting a RSP.
New investors could also find a DCA strategy to be more assuring and more suitable, particularly when they have little investment experience.
Most importantly, these options are not mutually exclusive. Rather, they can go hand in hand.
Does it matter which strategy you choose?
While there are bound to be differences in the performance of your portfolio should you choose DCA or lump sum investing, hindsight is always 20/20. As every investor’s investment goals, financial situation and investment preferences differ, the choice should be one that best suits your needs at that point in time.
You should also keep in mind that this is not a one-time decision. Lump sum investments can be done at any time with the click of a button. Similarly, you can stop or increase your regular investments whenever you see the need to.
What matters more is the way you execute these strategies.
- If you opt to DCA: You can do so via a regular savings plan or with your robo-advisor. This is more cost efficient than manually purchasing a security each month, which could incur higher costs, especially if you are investing a small amount.
- If you opt for a lump sum investment: Why pay more when you can pay less? Start by selecting a good brokerage account that offers lower commission fees. If you’re holding the security for the long term, you might want to consider a CDP-linked account to avoid charges such as custodian fees.
DCA & lump sum: Best of both worlds
You can make a lump sum investment today while continuing to dollar-cost-average and add to your portfolio. A great example of this is to make lump sum investments during times when you have a large amount of capital on hand – such as when you receive a bonus, cash out an endowment plan or strike the lottery.
Rather than sitting on the extra cash, or waiting for this cash to be invested over the next few months, you can invest it immediately.
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You can also employ these two strategies for different investment types. For example, you might want to employ DCA to grow your robo-advisory portfolio, while making lump sum investments when you see stocks that you’ve been eyeing at their 52-week lows.
Whether it’s via DCA or lump sum investing, what’s more important is to start investing as early as possible, to tap on the power of compounding to maximise the returns you reap over the long term.
This article was first published in SingSaver.com.sg.