DD started reading with sight words. She had hundreds--maybe thousands--by the time she was 3. At the same time, she couldn't read even a basic CVC word that she was unfamiliar with. Though I was a bit concerned that she was (relatively) behind on sounding words out, we didn't do any instruction unless you count playing on Starfall. But she taught herself on her own time. I'm not even sure when it happened. I know it did, because we tested her recently and she was in the 99.9th for reading nonsense words. In short, I wouldn't worry about it! I don't think that starting out with sight words is a handicap at all.
As for the method you should use to teach reading, I can't really comment. DD would not have accepted reading instruction at that age. I'd say try what you like but be flexible and keep in mind that attitude toward reading is much more important at this age than reading ability is. So keep it light & fun!
