The paper also compares the two strategies using 10,000 simulated-return scenarios that tested various types of portfolios and CA period lengths. Consistent with findings from the historical analysis, LS in most cases yielded greater wealth after one year, but also greater losses in some of the worst market environments.
Because not all investors aim purely to maximize their wealth, and because some might find value in taking a slower path to portfolio growth if it helps to avoid big losses, Finlay and Zorn tried to quantify a loss-averse investor’s preference for a lower-risk CA strategy. They constructed a utility model that considered hypothetical investors with varying levels of risk aversion and loss aversion and determined which strategy—CA or LS—each investor might prefer. They found that investors with significant loss aversion may be better suited for a CA strategy.
But Finlay cautions that even if you’re an investor with high loss aversion, it’s best to minimize opportunity costs by keeping a relatively short CA period, such as three months.
“A CA strategy is superior to remaining entirely in cash and, if implemented properly, may be more suitable for risk-averse investors,” she said. “But given the cost of holding cash for extended periods, most investors—particularly those who don’t have significant aversion to loss—should invest a lump sum immediately.”