These are two methods of investing which you could employ to enter your position in a particular stock or the market as a whole. Dollar Cost Averaging (DCA) is the process of adding a fixed amount or percentage of your capital to a particular position. For example, you could commit $200 per month to invest until you are comfortable with your position. By contributing a fixed amount on a regular basis you are automatically purchasing more if the investment down and less if it is up, hence getting to an average price. Be mindful if you are purchasing a stock or ETF and paying a commission every purchase as this will increase your over adjusted cost base. Contributing a fixed percentage allows more of your capital to be invested longer while still not committing all of your funds immediately. If you have $10,000 to invest you could consider allocating 20% of your funds every month until you have all funds in the market. The first month would be $2,000 invested.
The second month would be $1,600 as you would have $8,000 left after the first month and 20% of $8,000 is $1,600. Lump sum investing would allocate the entire $10,000 right away to your chosen investment. The advantages and disadvantages of DCA are the opposite for lump sum contribution. Investing in a lump sum would not provide an opportunity to average out the price of your investment. You are essentially hoping you are getting reasonable valuation at the time of purchase. The upside to lump sum investing is you now have your entire capital working for you right away. This can make a big difference in dollar figure returns. Let’s ignore compound returns just for the purpose of an example. Suppose instead of investing the entire $10,000 today you planned on splitting it evenly over the next 12 months. Again to illustrate a point let’s say during the first 6 months of the year that investment return 5%. In dollar figure you would have $833 x 6 = $5,000. $5,000 x 5% = $250. If you had invested the full $10,000 right away you would have $500. It’s very obvious considering you invested double the amount however it’s something investors need to consider when making their decision of how much to commit.