Dollar Cost Averaging vs. Lump Sum: The Definitive Guide
We often get asked by clients if we can take their lumpsum and deploy into x equal tranches over the next x weeks/months i.e, what is termed as ‘Dollar Cost Averaging’. Nick Maguilli of Ritholtz Wealth Management, in this blog supported by ample amounts of data driven analysis shows why you are better off deploying at one go as opposed to staggering it. The rationale is that whilst deploying at one go or staggering the investment both are random acts, in an upward trending asset class, a lumpsum increases the time for which the capital is at work. Using the S&P500 between 1997-2020, he shows that a lumpsum investing approach outperforms the 24 month Dollar Cost Averaging approach 78% of the time with an average outperformance of 5%. Even more counter intuitively, he shows that this outperformance sustains even on a risk adjusted basis with a greater Sharpe ratio. However, as one would expect, the outperformance reduces for riskier assets which have higher volatilities as the probability of the stagger picking up lower entry points grows. Indeed, for our Consistent Compounders strategy with significantly lower volatility, a lumpsum investment would outperform a staggered deployment most of the times. Of course, this doesn’t refer to the Dollar Cost Averaging or Systematic Investment Plans (SIPs) as commonly known in India where periodic cash inflows (such as salaries) are automatically channelised into an asset class – those would be more systematic savings plan as opposed to a staggered deployment strategy that the blog is referring to.