Why Lump Sum Investing Might Be Better Than Dollar-Cost Averaging
Most savvy employees invest by dollar-cost averaging or transferring a portion of their paycheck into a 401(k) or 403(b) account. This well-respected investment strategy buys more shares at lower prices and fewer at higher prices and lowers the average cost per share.
But what if you're among the handful of fortunate people with a lump sum of cash to invest at one time?
Maybe you came into an inheritance, saved up cash in your investment account or sold securities, leaving you with a sizable stash. If you're considering whether to reinvest the capital at once or drip it into your account bit by bit, here's why lump sum investing is better than dollar-cost averaging, most of the time.
[See: 7 Mistakes to Avoid With Dollar-Cost Averaging.]
The research supports lump sum investing. Vanguard studied this question by comparing the performance of lump sum investing with dollar-cost averaging. During 1926 through 2011, Vanguard found lump sum investing won the performance race 67 percent of the time during rolling 10-year periods.
The benefits of lump sum investing over dollar-cost averaging held true regardless of whether the investment was in all equities, all bonds or a combination of both asset classes.
"Dollar-cost average if you must, but better long-term results will come from lump sum investing," says John Madison, a financial coach at 60minutefinance.com.
Think of every dollar in your account like your employee. The sooner your employees do their job, the faster you get paid. "While dollar-cost averaging is a nice consolation prize for those who must invest slowly out of their cash flow, a lump sum invested now generally yields higher results," says Matthew J. Ure, an investment advisor representative and president of Anthony Capital's San Antonio office.
Although dollar-cost averaging helps manage the stress of worrying that the market will tank after investing a lump sum, it will likely cause investors to miss out on the potential returns of going all in today, says Daniel Ruedi, financial advisor at Ruedi Wealth Management in Plano, Texas.
Jason R. Escamilla, CEO and chief investment officer at ImpactAdvisor, calls dollar-cost averaging a market timing strategy. "Dollar-cost averaging should not be used for purposes of enhancing performance. Dollar-cost averaging is simply a risk reduction technique: It is easing into a proper long-term investment strategy instead of implementing it immediately."
Lump sum investing puts your cash to work immediately. Since the markets are up more than they are down, you significantly increase your potential returns by investing as soon as you have the cash, rather than drip, drip, dripping it into the market.
[See: 13 Ways to Take the Emotions Out of Investing.]
Unfortunately, despite the factors in favor of lump sum investing, humans are not rational and in many cases our emotions drive our behavior.
So, it's clear that lump sum investing wins -- maybe.
Dollar-cost averaging has its place in investment strategy. There are circumstances when you might be advised to dollar-cost average your cash into stock and or bond investments.
"Dollar-cost-averaging and lump sum investing both have their merits and the correct answer to which is better largely depends on the individual and their investment horizon," says Sam Dechtman, a certified financial planner and wealth advisor at Dechtman Wealth Management in Centennial, Colorado. If an investor is fearful of the stock market and has a shorter time horizon then it might be better to dollar-cost average. Dechtman says dollar-cost averaging is an easier investment pill to swallow if you might be tempted to pull out of the markets after a crash, putting you in a worse position than before.
Brandon Kreig, CEO and co-founder of Stash, an investing app that allows users to get started in the markets with five dollars, believes in dollar-cost averaging. "We encourage our millions of customers to use the dollar-cost averaging strategy. The market fluctuates, and no one has a crystal ball to predict what's going to happen," he says.
Ultimately, investment markets are volatile. This volatility is scary to many investors, encouraging a dollar-cost averaging approach to investing for some.
This is the longest bull market, ever. The current bull market began on March 9, 2009 and is tagged as the longest bull market ever. Today, with the S&P 500 index up 350 percent including reinvested dividends since March 2009, some investors are skittish that a crash is coming.
[See: 8 Great Investing Apps and Sites for Millennials.]
Despite the likelihood of lower long-term returns, dollar-cost averaging is suitable for some investors. And with a bull market getting a bit long in the tooth, there's a near-term likelihood that the market's due for a downturn.
So, for investors with a long time horizon, lump sum investing wins most of the time. From 1928 through 2017, the annual S&P 500 returns were up 73.33 percent of the time. Finally, economic expansions have been much greater in magnitude than bear markets, Dechtman says.
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