If you’re an investor, you’ve probably heard of Dollar-Cost-Averaging (DCA) and Lump Sum investing.
Both of which have their pros and cons.
But what if we could take the two and get the best out of both?
Enter Enhanced Dollar Cost Averaging (EDCA), another investment strategy that could optimise your investment returns.
Intrigued? Let’s find out more!
TL;DR: Enhanced Dollar Cost Averaging (EDCA) – The Best of Lump Sum Investing and DCA?
- Enhanced Dollar Cost Averaging is essentially investing more money when the market goes down and investing less when the market goes up.
- The strategy, as proposed by Lee Dunham and Geoffrey C. Friesen, can help investors outperform DCA almost 90% of the time.
- But, this also means that investors must be aware of the macro environment and will have to spend time researching and also time the market.
- Uninvested cash will also be a missed opportunity.
Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any investment product.
What is Enhanced Dollar Cost Averaging?
In our previous article, we talked about the pros and cons of Dollar-Cost-Averaging (DCA) and Lump Sum investing.
But for the uninitiated, the DCA strategy helps reduce the emotion involved when investing and lowers the cost basis over time, especially when investing during a bear market.
Meanwhile, lump sum investing could give you much higher returns than DCA, but only if you have the right timing (i.e. at the start of a bull market). Moreover, there are less fees involved when you invest in a lump sum.
According to OfDollarsAndData, it was found that lump sum investing outperforms DCA most of the time. Their research has found that DCA over a period of 24 months into the S&P 500 will lose out to Lump Sum Investing in most years (since bull markets are more common than bear markets). However, when bear markets occur, DCA starts to outperform Lump Sum Investing.
But remember, this is all backtested data and past performance is not indicative of future results.
So, how can we “win” and get the best returns with both strategies?
This is where EDCA comes in.
Just like Dollar-Cost-Averaging, EDCA is an investment strategy that invests in regular intervals, usually monthly. However, unlike DCA where you invest a set amount regularly, you would invest more during market downturns and less when the market goes up.
While DCA is a great and popular strategy, it does not react to new information available. Thus, EDCA seeks to improve returns by reacting to new market information.
According to a paper published by Lee Dunham and Geoffrey C. Friesen,
EDCA is most effective when applied to high volatility assets, when cash flows are highly sensitive to past returns, and during secular bear markets. Historical back-testing on equity indexes and mutual funds indicates that investor dollar-weighted returns can be enhanced by between 30 and 70 basis points per year simply by switching from DCA to EDCA.
Is it Really That Simple?
No! Of course not! If it were, we would all be swimming in money.
First of all, the paper does not consider the opportunities missed with uninvested cash. Secondly, how does one truly know where the market bottom or top is?
While savvy investors are able to source information that indicates a market bottom during a bear market, it is almost impossible to time the market right. This is the huge con to lump sum investing and EDCA shares this con as well, although it is not as greatly impacted.
Should You Practise EDCA?
With both aspects of DCA and lump sum investing incorporated, here’s how it ranks when it comes to these aspects:
|Emotional||Lump Sum Investing||EDCA||DCA|
|Time investment to do research||EDCA (you will need to stay on top of news and research constantly)||Lump Sum Investing||DCA|
|Risk level (relative to each other)||Lump Sum Investing||EDCA||DCA|
|Fees||EDCA/DCA||-||Lump Sum Investing|
Perhaps the most important is the time investment required. If you are a savvy investor with time on hand to research and understand macroeconomic factors, EDCA could be a good choice for you, especially during a bear market. However, for most retail investors, a DCA strategy could be better as it requires the least time investment.
Which strategy would you be employing? Comment below!