Enhanced Dollar-Cost-Averaging - an improvement for current mutual fund investment strategy
Date Issued
2012
Date
2012
Author(s)
Liu, Li-Wen
Abstract
Among the various financial instruments available in the market nowadays, mutual fund has become one of the most well-know and preferred investment choice for investors to manage their wealth. By investing in mutual fund, investors could enjoy the benefits of portfolio diversification, high liquidity of investment position, and professional management. Meanwhile, other factors such as the forceful marketing by banks, securities investment trust/consulting enterprises (SITE & SICE) or even financial consultants, as well as the convenient mechanism of application and redemption channel also contribute to the popularity of mutual fund investment.
Two main strategies are normally utilized in the mutual funds investment, Lump-Sum (LS) and Dollar-Cost-Averaging (DCA) strategy. Though the debate over which one has superior performance lingers for a long time and literatures in late period seem to prove that LS strategy could perform better, it’s undeniable that DCA is the mainstream strategy of mutual fund investment. Several reasons could explain why DCA becomes investors’ favorite investing strategy. First, the mechanism of regular deduction at agreed period resembles the concept of club deposit and it facilitates to achieve the forced saving plans. Second, monthly (or other regular intervals) contribution avoid the market-timing problem and also lessen the anxiety of making investment decisions. Then, based on the perception from most investors, DCA strategy could average the cost, reduce the investing risk, and the investing position could enjoy the power of compound interest over the long run.
However, the generally accepted concept that investors could make profit or accumulate expected wealth simply by following current DCA strategy is questionable. According to the simulation results in this study, it proves that the mechanism of current DCA strategy is not sufficient to help investors to make profit, and it is also not an appropriate investing toll for long-term investment without proper management. When investor decides to utilize DCA to invest in mutual funds, the information he will receive usually is the fund performance in the past. But investors is totally unaware of the fact that before his investing portfolio could make expected profit, to what degree the volatility he needs to tolerate? Meaning what’s the maximum investment loss he might need to put up with? And how long will the investment loss last? These are important factors to impact investor’s attitude toward his investing plan and also affect investor’s faith to stick to the strategy, which happens to be the key to the success of DCA strategy.
By simulating DCA in Taiwan Weighted Stock Index, this study believes that current DCA strategy contains some fallacy conception, such as negligence about the limits of investing life and capital constraints, lacking of clear method to realize profit, and being trapped in the bear market. To improve the investing strategy in mutual fund investment under the purpose of making profit, this study suggests the Enhanced Dollar-Cost-Averaging (EDCA®) strategy to make up for the deficiencies in current mechanism. Briefly speaking, EDCA requires investors to weight the investing duration and the available capital before deciding the monthly deduction amount. Then, sticking to the investing plan and increasing the monthly deduction amount in the bear market are crucial to accumulate investing position quickly and further lower the average cost. At last, redeeming the portfolio position at the set stop gain point is the key to the success of EDCA, since it prevents the profit from disappearing with market volatility and facilitates to accumulate wealth over the long run. This study utilizes historical data of different mutual funds to simulate the investing result between DCA and EDCA strategy and the results shows that regardless of the performance of individual mutual fund, EDCA does outperform DCA.
Subjects
Dollar-Cost-Averaging
Enhanced Dollar-Cost-Averaging
Stop gain
Volatitliy
Type
thesis
File(s)![Thumbnail Image]()
Loading...
Name
ntu-101-R97749022-1.pdf
Size
23.32 KB
Format
Adobe PDF
Checksum
(MD5):e706bb655e1e794deb2f3761a65cbfa1