It really boils down to your objectives and how disciplined you are, says DANIEL BUENAS.

Published January 29, 2007

A CONCEPT, or practice, that is often touted by financial advisers and those in the financial community is that of dollar cost averaging.

This means investing a fixed sum of money at a regular interval, regardless of how the market is doing.

However, while it is a commonly-used technique, not everyone feels that dollar cost averaging is a good practice. Some critics even claim that it is more of a marketing ploy, rather than a risk-reducing strategy.

So should an investor consider dollar cost averaging, or is one-time lump sum investing better? Before we examine that question, we'll relook at an example we've mentioned before on this page to better understand the concept.

Some retail investors try to 'time' their investments. If they are lucky, they may gain more, but could also lose more if they buy when prices peaked. Imagine if you wanted to invest $1,000 in company ABC whose stock is currently selling at $10.

SCENARIO 1: No Dollar Cost Averaging

If we bought it as it is, we get 100 shares of ABC with our $1,000. Assume 10 months have passed, and we decided to sell our ABC shares which have fallen to $5 a share. At that price, our shares would be worth a total of $500. Or we make a $500 loss.

SCENARIO 2: Using Dollar Cost Averaging

Now we assume we start out with the same $1,000, but this time we spend $100 at the start of every month for 10 months to purchase ABC shares.

The share price remains steady at $10 for the first five months, which means we purchase 10 shares a month for five months, or 50 shares.

For the next five months, the share price drops to $5 a share, which means we now purchase 20 shares a month for five months, or 100 shares.

At the end of the 10 months, we have accumulated 150 shares currently worth $5 each. If we sold them all, we would get $750. Or the loss is $250, compared to a $500 loss in our earlier example.

This illustration is simplistic, but it does demonstrate the basic principle of dollar cost averaging.

But some market watchers believe that dollar cost averaging may not be as effective an investment technique as some purport.

For example MSN Money Insight contributor Timothy Middleton says in a column on the MSN Money website: 'Dollar-cost averaging is easy to sell to nervous investors because calamities do happen in financial markets, and they can seldom be foreseen.'

However, Mr Middleton says calamities are 'astonishingly rare'.

'When the market is studied over long periods, dollar-cost averaging almost always produces lower returns than investing lump sums in diversified portfolios, and almost never reduces risk meaningfully,' he says, adding that investors should 'invest on any schedule you wish, (as) they all work out in the end'.

Salman Haider, Citibank Singapore's head of investments, points out that regular investing tends to perform better than lump sum investing when markets are volatile but trending upward.

As an illustration, he cites the three ways investors could have invested in global equities over the last 10 years.

'As you can see from the chart over the past 10 years, lump investing actually outperformed dollar cost averaging because of the strength of the global equities market,' says Mr Haider. 'However, not everyone has the money to put in a large sum at the outset, or the discipline to sit tight on their investments for a long period. Hence, a dollar cost averaging approach may be more realistic.'

So which should an investor choose?

'The answer really depends on your view of the market, your time horizon and objectives,' Mr Haider says. 'But generally speaking, if you are someone who does not want to worry about volatile markets, who wants to avoid letting their emotions get in the way, or to simply put some money aside for the future, then regular investing may be the option, as it allows you to build your wealth in a consistent and disciplined manner.'

However, he also points out that there are some benefits to dollar cost averaging, as regular investing does require discipline, which may be difficult, especially when markets are volatile.

'This is one reason why we encourage customers to sign up for a regular investing plan,' he says. 'With an automated process, you will keep to your plans and are less tempted to discontinue especially when markets are down. Such plans are also affordable; in most cases, you can invest with as little as S$1,000 initially, and $100 thereafter.'

A good option, he adds, would actually be to do both lump sum investing and dollar cost averaging by starting with a small lump sum and topping up with a regular savings plan.

'That way, you benefit from the best of both worlds,' he says. 'Investors should understand that investing is not about 'timing the market' but about 'time in the market'. So invest regularly, with a long-term view and stay disciplined in that approach.'