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Dollar Cost Averaging Vs Lump Sum Investment

Is Dollar Cost Averaging Better Than Lump Sum Investment?

Dollar cost averaging is an investment strategy to purchase stocks by investing equal amounts at regular intervals. It reduces the impact of volatility on lump sum investment of financial assets such as stocks. Being the old school of thought, dollar cost averaging minimises the downside risk of a lump sum investment. But such approach may not be always most profitable.

Dollar Cost Averaging Vs Lump Sum Investment

Dollar averaging works better when the market is falling to reduce the average cost of stocks bought during this market declining period. It gives investors a better peace of mind of investing in a downcycle instead of showing hand to catch a falling knife. When the market recovers, everyone is happy regardless of whatever reasons they can be.

However, if we do a detailed back tracking comparison using an example of investing $12,000 into S&P index fund (with 0.2% annual fees) at its peak before the sub-prime crisis (Oct 2007) and at its start recovery point of sub-prime crisis, (Feb 2009) with an assumption of a bank interest rate of 3%, then you can see the virtue of lump sum investment and dollar cost averaging.

dollar cost averaging

Investment Amount at the peak before the sub-prime crisis:

  • Lump Sum investment = $12,000 (Oct 2007)
  • Dollar Cost Averaging = $1,000/month (between Oct 2007 to Sep 2008)

Investment Value after 12 month period:

  • Lump Sum investment = $7594.26 (Sep 2008)
  • Dollar Cost Averaging = $8490.46 (Sep 2008) [ lower loss ]

Investment Amount at the start recovery point after the sub-prime crisis:

  • Lump Sum investment = $12,000 (Feb 2009)
  • Dollar Cost Averaging = $1000/month (between Feb 2009 to Jan 2010)

Investment Value after 12 month period:

  • Lump Sum investment = $13,056.40 (Jan 2010) [higher gain ]
  • Dollar Cost Averaging = $11,614.58 (Jan 2010)

Lump sum investment may give you better returns if you invest near or at the bottom of the stock or index market. But no matter what, one can never predict accurately the peak and bottom of a stock or index market.

If you are new to stock investing, perhaps dollar cost averaging is a more disciplined approach for a good start in investing and it can give you a more stabilized returns over a longer period of time. If you are a seasoned stock investor who understand how value investing works, you may prefer a lump sum investment when your target value stocks are undervalue. That’s just my personal opinion. Do your own due dilgence. Happy investing!

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