Asian Review of Financial Research Vol.23 No.1 pp.55-88
Does Dollar-Cost-Averaging Strategy Really Outperform Lump-Sum Strategy in the Fund Investment?
Key Words : Fund Performance,Investment Strategy,Dollar-cost-averaging,Lump-sum,Individual Accounts
The Korean fund market has experienced a tremendous growth in the past several years. Especially, the growth in the equity type fund has been phenomenal; for instance, its balance grew from 6.5 trillion won in March 2005 to 127.7 trillion won as of November 2008. While low interest rate and steady growth trend in the world stock market have driven the increase in the market size, the introduction of systematic monthly fund investment method, which is virtually the dollar cost averaging investment, has also played a significant role. In fact, since its introduction, fund distributors often advise individual investors in favor of the dollar cost averaging method, asserting that it generates higher returns with lower risks compared to the lump sum investment strategy; accordingly, many individual investors have participated in equity-type fund investment. This study aims to compare the performance of the lump sum (LS) investment strategy and dollar cost averaging (DCA) investment strategy in the Korean mutual fund market to check whether the DCA method really outperforms the LS method. Thus far numerous debates have followed over which of these two investment strategies is better since Constantinides (1979) which suggests that the LS investment strategy outperforms the DCA investment strategy. Prior to his paper, it was generally accepted that DCA is better than LS due to the dollar cost averaging effect. However, many theoretical and empirical researches since Constantinides (1979) have suggested that LS actually outperforms DCA. Most of the literature on this issue, regretfully, has been solely based on theoretical analysis or simulation methods only. Even empirical analysis has relied on hypothetical accounts rather than actual investment accounts. In this regard, this paper is different from the past literature in that we used not only the conventional simulation methodologies, but also individual investors' actual account data to effectively compare the performance of LS and DCA investment strategies. The data for this paper are comprised of: i) KOSPI stock index and bond yields from January 1988 to December 2008 for the historic simulation; ii) KOSPI stock index and bond yield from January 2001 to December 2008 for Monte Carlo simulation; and iii) 36,890 individual accounts (of which 22,449 using DCA strategy and 14,441 using LS strategy) from December 2004 to November 2008 for the real investor data analysis. Our major findings are as follow. First, the historic simulation shows that LS investment strategy provides better return for short-term investment horizon (1 year) while DCA investment strategy outperforms for the long-term investment horizon (3 year and 5 year). This result holds robust whether we use simple return, Sharp measure, or Jensen's alpha to measure the fund account performance. The Monte Carlo simulation shows similar results: the LS investment strategy gives better return for the 1 year investment horizon. For the 2 year investment horizon both strategies are comparable while DCA starts to outperform LS when the investment horizon is longer than 3 years. Second, we use individual fund investment account data to compare DCA and LS strategies and find that DCA outperforms LS during our study period which is divided into bullish period and bearish period. We find that the marginal effect of DCA on the risk adjusted return (Jensen's alpha) is positive even after controlling for the market conditions. It is also found that DCA becomes a better investment strategy than LS when the investment term is longer and the investment capital is larger. Third, we compared two different methods to close down DCA investment account. Fund investors with DCA account can either choose automatic sell-off when their monthly saving contract matures or wait to select the better time to sell-off his or her fund even after the contract term expires. We find that investors who choose different sell-off time other than automatic contract expiration time do not perform better, and this indicates that investors as a group do not have ability to choose better investment exit time. Finally, we conduct the sensitivity analysis for the fund investment in response to the changes in the stock prices. We find that both fund purchase and fund sell-off are sensitive to stock price movements. Both purchase and sales of fund increase when the stock price (KOSPI index) rises, and they decrease when the stock price falls. Between the purchase and sales, fund purchase activity is more sensitive to the stock price movements than fund sales activity is while LS investors are more sensitive than DCA investors are. Our study result suggests that individual equity type fund investors are better off when they invest with DCA strategy and for a longer time horizon. This paper makes a meaningful contribution to the fund and investment literature as it is the first paper to examine the actual investors' account to compare the DCA and LS fund investment methods. Nonetheless, we acknowledge that some part of the result may be sensitive to the study period.