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  • Daniel Lee

When to do what: Dollar cost averaging or Lump sum investing

In this article we will be exploring, the pros, cons and when you should consider lump-sum or dollar cost averaging when implementing your investment strategy.


To support our analysis, we will examine the historical records from 2005 to 2020 for the world's index.

Lump Sum Investing

What is it: Investing an entire amount at one go?

Typical nature of analysis needed: Bottom-up approach


Pros:

  • Most effective way of chasing returns if performed correctly

  • Investment returns may be driven by market volatility or fundamental returns of underlying investments or both

  • Suitable for all investment horizon depending on underlying strategy


Cons:

  • If performed wrongly, may result in significant losses.

  • heavily subjected to market timing

  • requires technical knowledge and access to relevant information to aid in your judgment


In terms of investment returns, not accounting for dividend returns, if you

  • time it wrongly and invest in 2007, your yearly returns would be 0.19%

  • time it perfectly and invest in 2008, your yearly returns would be 6.80%


This will translate to an end value of (x) for an investment of $100,000

  • time it wrongly and invest in at 2007: $129,297

  • time it perfectly and invest in 2008: $343,655


Long story short:

Lump sum investing should be performed when you are confident that an investment is worth investing in at that specific timing.


This can only be formed through proper and thorough analysis which requires an access to relevant information from which most retail investors may not have (e.g. Bloomberg terminal).


Dollar Cost Averaging

What is it: Investing a fixed amount every month over a long period of time.

Typical nature of analysis needed: Top-down approach


Pros:

  • removes the detrimental effects of market timing and volatility

  • reduces the likelihood of poor decisions driven by emotions

  • investment returns are driven by the fundamental returns of the underlying investments


Cons:

  • must be disciplined and plan properly or the effectiveness will be reduced

  • choosing the right underlying investment is exceptionally important

  • typically requires a long-term investment horizon


In terms of investment returns, not accounting for dividend returns, if you

  • started investing in 2007, your yearly returns would be 3.40 %

  • started investing in 2008, your yearly returns would be 3.96 %


This will translate to an end value of (x) for an investment of $100,000 ($10,000 x 10)

  • Started investing in 2007: $175,842

  • Started investing in 2008: $173,398


Let’s not forget, I have not included the returns from plausible money market funds where you park your funds before deploying them during this DCA duration.


Long story short:

Dollar cost averaging should be performed when you are more focused on capturing the long-term growth of your underlying investment (e.g. growth of Asia).


This only requires you to put in the time to understand the underlying drivers behind the returns of your investment but not to an extent where you can decipher whether it is a “good time to invest”.


What method do I use and how do I implement my investments?

Personally, when it comes to my approach for portfolio management, I will always structure a long-term dollar cost averaging strategy as the core of the portfolio. (a.k.a strategic asset allocation)


That should provide a yearly return rate, after dividends, of 5 – 12% depending on the asset allocation of your portfolio.


I will then allocate 10-20% for lump sum investing into very narrow funds based on my analysis of specific markets. (a.k.a tactical asset allocation). This will help provide the additional returns needed to your overall portfolio without putting yourself into risky positions.


At the end of the day, there’s no good or bad approach, there’s only right or wrong approach depending on your own financial and investment plans.


Naturally speaking, that is if you have a clear understanding of your own investment objectives and financial plans in the very first place.


If you are reading this and would like to kick start your retirement or investment planning, you can reach out to me here and I’ll help you make sense of the options available at your current stage.


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Daniel is a Licensed Financial Consultant with MAS, who specializes in retirement and investments planning. Find out more here.

Disclaimer:

This article is meant to be the opinion of the author and is for information purposes only.

This article should not be seen as a financial advice

This advertisement has not been reviewed by the Monetary Authority of Singapore