For those unfamiliar with the term Dollar cost averaging (DCA)
is an investment strategy for reducing the impact of volatility on large purchases of financial assets such as equities. By dividing the total sum to be invested in the market (eg \$100,000) into equal amounts put into the market at regular intervals (eg \$1000 over 100 weeks), DCA reduces the risk of incurring a substantial loss resulting from investing the entire "lump sum" just before a fall in the market.
Dollar cost averaging appears to perform worse than lump sum investment. If this is the case, then why do a lot of people engage in dollar cost averaging instead of lump sump investment?
My own guess is that dollar cost averaging "allows you to sleep better" at night because the chances of making catastrophic losses are smaller than lump sum investments; in other words, loss aversion is at work here.
Am I right? In other words, I have two intertwined questions here
- Does dollar cost averaging have a lesser chance of blowing up?
- If yes, is this why people prefer it?