Dollar-Cost Averaging, Asset Allocation, and Lump Sum Investing

Abstract

Both practitioners and academics have long disputed whether investors should choose dollar-cost averaging (DCA) or lump sum investing (LS) as their investment strategy. While the issue still has not been completely settled, this study shows that an endeavor to make a performance comparison between DCA and LS might not be completely relevant. In this article, we demonstrate theoretically, numerically and empirically, that DCA is approximately equivalent to an asset allocation strategy in which about 50%–65% of wealth is invested in risky assets and the rest in riskless assets, while LS is the same as a 100% risky asset allocation. With different proportions of risky assets, DCA and LS are suitable for different types of investors with different levels of risk tolerance; thus, DCA and LS should not be compared. We emphasize that DCA should be recommended only to moderately risk-averse investors and should be compared with a 50%–65% risky asset allocation instead of to LS. Compared with a 50%–65% risky asset allocation, we also show that DCA is ineffi cient, as it lies below a capital allocation line. Thus, investment advisors should recommend DCA to their clients with caution because a 50%–65% risky asset allocation is superior to DCA.