When Should You Invest via Lump Sum and Dollar Cost Average
Let’s talk about when you should invest via Lump Sum and when should you invest via Dollar Cost Averaging.
While there is an endless debate over which method is better, the suitability of the investment method largely depends on the market condition and the type of analysis that was conducted.
When to Lump Sum?
You should consider investing via lump sum if your investment operation focuses on bottom-up analysis and you can calculate, with a high degree of accuracy, the intrinsic value of the investment.
Doing so allows you to maximize your returns by capturing the differences between the current price and theoretical intrinsic value should the price correct itself to reflect the intrinsic value of the investment.
That said, while lump sum investing may provide higher returns if you can “time the market” accurately, it also exposes you to a higher risk of losses should you “time the market” inaccurately.
For example, if you were to invest in the MSCI World Index via the lump sum basis (2005 to 2020) if you “time the market”
accurately, the yearly return would be: 6.80%
inaccurately, the yearly return would be 0.1
When to D.C.A?
On the other hand, you should consider investing via dollar cost averaging if your investment operation focuses on top-down analysis and if you have difficulties in ensuring high accuracy in your intrinsic value calculation.
Doing so allows you to eliminate the probability of selecting the wrong entry price by averaging the cost price of your investments over a period of time.
By dollar cost averaging, you are now able to capture the long-term fundamental growth of the underlying investments and eliminate the ups and downs of the market that is driven by irrational short-term speculation.
That said, while dollar cost averaging may help lower your investment risk, it also limits your expected return to the long-term fundamental growth of the underlying investment. As such, you must select your underlying investment carefully.
For example, if you were to invest in the MSCI World Index via the dollar cost average basis (2005 to 2020), if you “time the market”
accurately, the yearly return would be: 3.96%
inaccurately, the yearly return would be 3.40%
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Daniel is a Licensed Independent Financial Consultant with MAS and a Certified Financial Planner (CFP®).
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This article is meant to be the opinion of the author
This article is for information purposes only
This article should not be seen as financial advice
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