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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 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 loss is smaller than lump sum investment; in other words, loss aversion is at work here.

Am I right? In other words, I have two intertwined questions here

  1. dollar cost averaging has a lesser chance of blowing up, and
  2. If yes, this is why people prefer it?
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Just curious, if you have \$100,000 to invest and you are putting \$1000 into the market each week, where does a DCA investor put the remainder of their money (i.e., the \$99,000 in week 1, the \$98,000 in week 2, etc.). Surely the performance of that implicit investment is particularly relevant to evaluating the DCA strategy. –  Jeromy Anglim Mar 5 '14 at 7:12
@JeromyAnglim, usually the DCA investor will put it in a risk-free investment such as bank. It is on this basis that most frequently the performance of DAC and Lump Sum is compared –  Graviton Mar 5 '14 at 7:16

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