In the exciting sphere of financial investing, dollar-cost averaging (DCA) has long been a favorite strategy. Its appeal lies in simplicity – regularly investing fixed amounts over time to mitigate the risks associated with market volatility.
However, a newly introduced methodology, Enhanced Dollar Cost Averaging (EDCA), promises to improve the game. Developed by scholars Lee M. Dunham and Geoffrey C. Friesen, EDCA endeavors to outshine DCA by incorporating an element of market timing and investment capital adjustment.
But does this make EDCA a more effective strategy than the tried-and-true DCA? This is the question we seek to answer as we venture into the nitty-gritty of these investment strategies.
EDCA vs. DCA: At a Glance
These strategies, while similar in certain aspects, has unique characteristics that distinguish them. Understanding the intricacies of each can help investors determine the most suitable strategy for their financial goals.
Investment aspects |
EDCA |
DCA |
Goal-oriented investing |
Yes | Yes |
Investment horizon |
Yes | Yes |
Risk level |
Varies depending on the types of investment vehicles | Varies depending on the types of investment vehicles |
Response to market changes |
Requires changes in investment strategies like investment amounts | No change |
Time and effort into investing decisions |
Yes |
No |
Cost | Higher |
Lower |
Investment vehicles | Applicable to investments catering to regular and irregular contributions, such as mutual funds, money market accounts, stocks, exchange-traded fund investments, investment-linked savings plans |
Applicable to investments catering to regular and irregular contributions, such as mutual funds, money market accounts, stocks, exchange-traded fund investments, investment-linked savings plans |
Investment strategy | High |
Low |
Costs | High |
Low |
EDCA requires timely adjustments in investment strategies like the amount invested, offering a potentially higher return but at a higher cost. On the other hand, DCA remains consistent regardless of market fluctuations, making it a lower-cost, lower-effort strategy.
What is Enhanced Dollar Cost Averaging (EDCA)
EDCA is a modified technique of the conventional DCA used in investing. This new investing strategy emphasizes discretionary decision-making in addition to a DVA. The ECDA theory states that investors buy low when the market is down and stop investing when the market rises.
The two assistant professors state investors should invest only after a period of negative returns and stop investing after a month of positive results. The investment strategy also applies to additional or lump sum investing in addition to normal amounts.
Advantages
- Active management: The DCA is a passive investment strategy allowing investors to invest regardless of asset prices. EDCA investors should time and control investment amounts to reap benefits from possible depressed prices.
- Market timing: EDCA captures the pricing gaps during the depressed levels to maximize returns when the market goes up later.
- Investment amounts: EDCA allows investors to adjust investment capital. For instance, an investor can begin essentially investing or increasing contributions to maximize returns. During market highs, he can withhold investments and reduce losses due to high entry.
Disadvantages
- Opportunity costs: Enhanced dollar cost averaging strategy requires you to hold ready cash to prepare for investments in market downturns. During a long bull stock market, you may miss many profitable opportunities. You may regret seeing the investment moments pass while sitting on idle cash piled up.
- What’s a market low: Investors’ views on “low” differ, leading to different interpretations and results among investors. The lack of objective guidelines makes the theory hard to implement.
- Market timing difficulty: Investors may need to determine a market timing opportunity accurately. A stock price may slide further even though an investor thinks it has reached the bottom. Finally, the investor suffers further losses.
Case Study
Mr. Chen applies the EDCA tactic to invest in a stock exchange-traded fund. He intends to invest S$24,000 annually for the first 2 consecutive years and hold over the remaining 5-year investment period. Mr. Chen must decide whether any EDCA and DCA are best for him.
Here is how an EDCA works:
Year 1
(Market return – 15%) |
Year 2
(Market return + 15%) |
Year 3
(Market return + 10%) |
Year 4
(Market return + 5%) |
Year 5 (Market return + 8%) |
|
Investment cash flows (beginning of a year) |
0* (bull market and no amount invested) | S$48,000 (2 years’ investment amounts) | S$5,5200 | S$60,720 | S$63,756 |
Account balance (year end) |
0 | S$55,200 | S$60,720 | S$63,756 |
S$68,856.48 |
Investment return | 0 | 15% (S$7,200) | 10% (S$5,520) | 5% (S$3,036) |
8% (S$5,100.46) |
*In this scenario, Mr. Chen withholds investing during the market slide and begins investing after the market falls by 15%.
What is Dollar Cost Averaging (DCA)
DCA is a fixed-dollar-amount investment strategy used to reduce market risks. Investors regularly buy assets in constant dollars and over a specific investment period, irrespective of market prices, to avoid timing the market. An investment portfolio reduces pricing risks through multiple market entries.
The investing technique differs from lump sum investing as DCA involves many prices in a portfolio. In contrast, a lump sum investment only has fewer or 1 price level.
Advantages
- Timing market: Studies show most investors are wrong in timing the market. The dollar-cost-averaging tactic can eliminate emotional factors and judgment errors in decision-making. A regulative and automatic investment style makes investing scientific and goals more achievable.
- Pricing risks: DCA averages asset prices through multiple market purchases. The ultimate averaged price is a more balanced value, more representative of a fundamental value of an investment in the market.
- Hassle-free investing: DCA is a hands-free investing style letting people focus on other businesses and personal matters. The investment runs for itself.
Disadvantages
- Investment cost: DCA involves more trades than lump sum investments. Studies show lump sum investors outperform DCA ones as more trades from DCA generate more trading costs than lump sum investing.
- Missed market opportunity: Lump sum investors using the strategy may risk sitting on cash on hand and missing a bull market. DCA stresses averaging pricing strategy through multiple prices and may fail to beat a single price tactic used by lump sum investing.
Case Study
Mr. Chen is reviewing DCA viability. After studying the mocked results of EDCA, he imitates the case by using DCA this time.
Here is how DCA works:
Year 1
(Market return – 15%) |
Year 2
(Market return + 15%) |
Year 3
(Market return + 10%) |
Year 4
(Market return + 5%) |
Year 5 (Market return + 8%) |
|
Investment cash flows (beginning of a year) |
S$24,000 | S$24,000 | S$51,060 | S$56,166 | S$58,974.30 |
Account balance (year end) |
S$20,400 | S$51,060 | S$56,166 | S$58,974.30 |
S$63,292.24 |
Investment return | -15% (-S$3,600) | 15% (S$6,660) | 10% (S$5,106) | 5% (S$2,808.30) |
8% (S$4,717.94) |
Mr. Chen sees the differences in the results through the simulation comparison:
Investing years |
Year 1 | Year 2 | Year 3 | Year 4 |
Year 5 |
Differences in returns(EDCA – DCA) |
0 | S$540 (S$7660 – S$6,660) | S$414 (S$5,520 – S$5,106) | S$227.70 (S$3,036 – S$2,808.30) |
S$382.52 (S$5,100.46 – S$4,717.94) |
Mr. Chen decides EDCA has a better edge over DCA with its better total return of S$1,564.22.
Factors critical in choosing EDCA and DCA
Though the tests prove EDCA a better strategy than DCA, you should consider other factors relevant to your investment strategies to succeed in the investment market:
- Research: You may research investment climates, like stock market performance and your buying targets, to know the investment trends for EDCA investing, while DCA has no issue with this.
- Market timing: You can predict the pricing trends for stocks in EDCA so that you can find entry points. DCA is exempt from it.
- Emotion: You have better control over your investing behavior as you may refrain from investing in a bull market. DCA uses automatic investing.
Grasping the investing knowledge about EDCA, you are more likely to succeed in using the EDCA tactic. Otherwise, DCA is a stable and controllable strategy.
See Also: Micro-Investing and Investment Course Singapore
Which is Right For You?
Examples of situations where EDCA may be more appropriate
As EDCA is a more sophisticated investment strategy than DCA, experienced investors are more confident than beginners in controlling their investment performance concerning emotion and knowledge.
Besides, experienced lump sum investors can use the technique to maximize returns offered by EDCA; however, DCA does not allow the option.
Examples of situations where DCA may be more appropriate
Investors new to the field can begin with DCA as the technique requires fewer complicated strategies than EDCA.
Moreover, busy people can use the hassle-free DCA to benefit from price diversification and grow their wealth without active involvement.
Final Thoughts
Both EDCA and DCA have their pros and cons concerning investing. Experienced investors are likely more successful in using the EDCA strategy. In contrast, beginners and busy investors should begin with the passive and risk-diversified DCA tactic.
Key takeaways
- EDCA invests during a market downturn while refraining from investing in a rising market.
- EDCA requires sophisticated investment knowledge like market research, timing, and emotion control to succeed while DCA is a passive and hands-free investment strategy.
- EDCA suits experienced or lump-sum investors, while DCA fits beginners and budget investors.
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