Investing 101: Approaches To Getting Invested

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How to get invested

Getting invested is the first step when seeking to preserve and potentially grow wealth over time.

There are a number of ways to do this, and the selection of which approach to take will depend on individual desires, goals and circumstances.

We explore three approaches:

• Lump sum investing
• Dollar cost averaging
• Dip buying

Lump Sum Investing

A lump sum investing approach involves investing the entire sum in question at once, gaining immediate exposure to the desired asset.

The investor becomes fully exposed to any gains or declines in the price of the asset and is in a position to receive any potential dividend or coupon payments from the asset from the time of investment onwards.

Making an immediate lump sum investment gives the investment a longer period over which any gains may accumulate. Total returns may also benefit from the compounding of returns on any gains on reinvested income.

Should the asset price decline, there is full exposure to the downside. If such a decline is seen as a temporary pullback and a potential entry point, note that no funds remain to further invest in order to benefit from the lower price. A lump sum investing approach benefits from simplicity, and it may result in lower total transaction costs compared to some other investment approaches since it only involves a single transaction.

Dollar Cost Averaging

A dollar cost averaging approach involves investing a series of amounts over a period. This could be a single investment amount invested in portions over a certain interval, or it may be an ongoing series of regular investments.

Investments are typically made regardless of the price of the asset. Prices may fluctuate over time and thus vary by investment point.

Source: Citi Wealth Investment Lab. This hypothetical scenario was created for illustrative purposes only and does not reflect any actual client account/data. *Net of fees.

The table shows a hypothetical example in which an investor invests $100,000 spread as five quarterly $20,000 investments. In the example, the price per unit is the same at the start and end of the period but fluctuates during the time frame. In total, 1054 units are purchased, 54 more than if the $100,000 had been invested in a lump sum at the start of the period. The average price paid of $94.98 is lower than the price in 3 of the 5 example quarters.

A dollar cost averaging approach can be attractive for investors concerned about investing at a relatively high price who wish to retain the ability to benefit from any potential price declines during the investment period.

However, in a rising market, a dollar cost averaging approach can lead to buying at higher prices and getting fewer units compared to investing via a lump sum at the start of the period.

A dollar cost averaging approach may also incur higher total transaction costs than a lump sum investing approach as it involves a greater number of transactions.

Since the overall investment amount is progressively invested over time with this approach, an investor isn’t fully exposed to any changes in the price of the asset, or any resultant income streams, until the full amount has been invested.

Dip Buying

A dip buying approach involves waiting to invest until there is drawdown in the asset price (a ‘dip’), and then investing some (or all) of the total investment amount.

The extent of the asset price drawdown required to be considered a dip may be a fixed level or percentage that an investor decides in advance, or the investor may assess the market on an ongoing basis and make a subjective determination on when to invest.

Investors who follow a dip buying approach believe that the price of the asset will decline in the near term before appreciating, and hope that by waiting for a price dip they may be able to purchase the asset at a lower price, thereby benefitting from potentially greater subsequent price appreciation than should they purchase the asset at its current price.

There is no guarantee that the price of an asset will fall during an investor’s time frame, however, and an investor could be left without exposure to the asset including to any potential income stream it may pay.

Should the asset price decline as anticipated, and the investor makes the purchase at this lower price, there is no assurance that the asset price would subsequently appreciate during the investor’s time horizon. Should the asset price continue to decline, the investor would have purchased the asset at a higher price and received fewer units than may have been possible by purchasing later.

Comparing approaches

To illustrate how the three approaches might compare, they were applied to making an example hypothetical investment into the MSCI World Index of global equities, held for 5 years.

The example considers investment approach parameters below and assumes that any uninvested funds are held in cash:

The lump sum investing approach invests the full amount at the start of each 5-year period. The dollar cost averaging approach invests 20% of the amount over each of five quarterly instalments during the first year, with the first instalment occurring on day 1.

The dip buying approach invests a third of the amount whenever there is a month-on-month price decline of 10% or more, until all cash is invested (up to 3 investments). As such declines did not occur in all instances, not all cash is invested on all occasions.

Source: Citi Wealth Investment Lab, FactSet financial data and analytics using monthly data Jan ‘78 – Jun ‘24. MSCI World is the MSCI World Net Total Return Index.

When comparing the results from investing according to the three approaches, the lump sum investing approach showed the highest average annualized returns and volatility in the example, consistent with being fully invested in the index during each period.

The dollar cost averaging approach had slightly lower average annualized returns, partially reflecting the time it took for the amount to become fully invested each period. It showed slightly lower volatility compared with the lump sum investing approach, reflecting the spreading of investment across time and price points.

The dip buying approach had the lowest average annualized returns and volatility, due to the investment spending more time held as cash. This approach had a lower frequency of both higher and lower returns, as shown in the chart to the right.

The dip buying approach missed out on strong rallies in the index as it failed to get invested, but also benefitted from never entering at the highest observed price, thereby also reducing the extent of its exposure to downturns.