One of the down-to-earth, no frills, low-risk and almost surefire investing method is Dollar Cost Averaging, or they call it DCA in short. DCA is simply buying a particular stock/fund with a fixed amount of money on a regular basis. This method works based on “buying more when price is low and less when price is high”. To get a better illustration, visit the post from The Digerati Life – You’ve Got Money: Invest It All or Dollar Cost Average?, where she did a great job in explaining what DCA is, and also compare it to other methods – Lump Sum Investing (LSI) and Value Cost Averaging (VCA).
So, how did DCA fare against the other two? It is clear from the table of comparison in the post that LSI yields the best performance while DCA’s return is mentioned as being the least. To reinforce this stand, Moneychimp compared DCA and LSI numerically. Judging on their 12 month returns based on actual S&P 500 historical data, LSI outperform DCA majority of the time. You can access their cool calculator here.
Does it mean you should do LSI and not DCA? Not really, you have to find the method that is suitable to you.
Use LSI if you have:
- Capital, or have the discipline to save up capital
- Time and ability to locate the market low
- Patience to hold on to your investment even when you have large paper losses
Use DCA if you do not have:
- Large capital but have a steady stream of income where you can regularly set aside a portion for investment
- The discipline to save up capital for investment
- The time to monitor the market
I highly recommend readers who are unable to save money to practise DCA as it forces you to set aside the money for your financial future. Picture a person who thinks that LSI is a better method and starts saving a portion of his monthly salary to build capital. It was fine for several months until he was enticed to buy the new HD flat LCD TV that will fit perfectly in his house. Now, the capital that he was trying to raise is gone. So much for saving for the best (performing method). He would be better off with DCA, even though the returns maybe smaller. Hence, it is unwise to choose a method based on the returns that it can provide. You must instead choose a method that fits your personality and psychology.