Investment Strategy: Dollar Cost Averaging vs Lump Sum
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It is important for you to choose your investment strategy before you start. In this article, we will be discussing about two different investment strategy that are commonly used for investing in Mutual Fund, Dollar Cost Averaging (DCA) and Lump Sum. Have you heard about these two terms? Read through!
Dollar Cost Averaging (DCA) vs Lump Sump
DCA strategy is one of the investment method of setting aside fund to be invested periodically. The amount could be the same or different in every period, however generally the fund is investment into the same product. The investment period for DCA strategy also depends on each individual, it could be weekly or monthly. On the other hand, lump sum is an investment method of collecting the fund first and then invest all at one period in the same investment product.
Understanding the risk prior to investing is always important. Other than risk in the product itself, the investment strategy you choose could pose different risks. As a beginner, DCA strategy is more advisable as this strategy could help reduce the investment risk. How?
This is due to DCA strategy allows you to invest at different period of time, which also means different market period. As you have known, capital market condition is always variative that it is hard to guess the market direction. By investing periodically, you have diversified the investment risk of your portfolio, while it is different from lump sum strategy as you only invest at one period of time.
To be able to understand when is the right time to apply DCA strategy or lump sum, let’s take examples of market scenarios: uptrend market and downtrend market.
Year of 2008 – downtrend market (bearish)
In year 2008, Jakarta Composite Index (JCI) had negative performance of -51% within the year. Let’s compare the return from the two investment strategy. If you apply lump sum strategy within this condition and invest a total of Rp 120 million at the beginning of investment period for one year, the return at the end of the investment period will decrease by 51% into approximately Rp 59 million. However, if you invest using the DCA strategy and invest your fund on monthly basis with the amount of Rp 10 million, the total return by the end of period will decrease by 34% or the amount at the end of investment period will be approximately Rp 79 million. In this condition, DCA strategy could reduce the risk of total return decrease by around 17%.
Year of 2014 – uptrend (bullish)
However, does the above result also apply to uptrend market condition? Let’s check it out by taking year 2014 as the scenario example, when the market performed positively and increased by 22%. If you use lump sum strategy and invest your fund of total Rp 120 million at the beginning of the investment period for one year, the total return of your investment will increase by 22% into approximately Rp 146 million. However, if you invest with DCA strategy where you invest your fund on monthly basis with the amount of Rp 10 million every month, the total return of your investment at the end of investment period will have an increase of 8% into around Rp 129 million.
From the two scenarios examples above, we could see that both strategies have their benefit at certain market conditions. Hence, you could choose and implement the investment strategy that suits you most in terms of risk profiles and investment horizon. The most important is to still invest regardless of which strategy you choose.
However, guessing the market direction is not an easy task and requires high skills. Therefore, for beginners it is more advisable to utilize DCA strategy to be able to minimize investment risk and take advantage of market condition in all period. Plus, if you try collecting all the money to be invested all at once, there is bigger challenge to this: the desire to shop! So it is better to set aside the fund and invest it periodically using DCA strategy.