Dollar Cost Averaging vs. Lump Sum Strategy Backtest – Managing Sequence of Return Risk

Most investors and traders are aware of the differences between dollar-cost averaging vs lump sum investing. But what role do luck and randomness play in determining the best strategy – dollar-cost averaging or lump sum investing? In this article, we dig a bit deeper and turn the returns over the last twenty years upside down to look at the sequence of return risks via backtests.

This article defines the difference between dollar-cost averaging and lump-sum investing. We explain what it is, why lump-sum investing is the best option, and finally, we look at how dollar-cost averaging is exposed to sequence of return risks. As our backtests prove in this article, you might underperform massively by dollar-cost averaging if you are “unlucky” with your timing and sequence of returns.

Investing in stocks for the long-term has produced excellent returns over the last 120 years. We are told to save, invest, and forget about it. Unfortunately, few of us live for 120 years and we are thus prone to the sentiment of Mr. Market in the “short-term”. In a time span of 120 years, we would consider 20 years as “short-term”. To smooth returns and not be a victim of Mr-Market’s mood swings, many suggest using dollar-cost averaging.

Why invest for the long-term?

This website is mainly about short-term trading, but we also like to invest in stocks and mutual funds for the long term. We believe every trader should invest a portion of their assets outside their trading. This is done to mitigate and reduce the risk of adverse short-term blunders. You need to be diversified in terms of time frame.

How do you allocate your long-term capital?

You can invest all your capital at once (lump sum) or you can invest gradually. The latter is called dollar-cost averaging:

What is a dollar-cost averaging (DCA) strategy?

It’s an investing strategy where you invest a sum of money via many installments spread out in time. This is the opposite of a lump-sum investment done once or just a few times.

Dollar-cost averaging is thus a strategic investment over time. For example, you might invest 250 USD at the end of every month, 12 times per year. You might do this for 10 years and you are spreading out your investment at different price levels.

Lump-sum investing involves investing in t