One of the biggest challenges in personal finance is deciding when to invest a sum of money. Whether you have $1 million to invest or $1 dollar the question is:
Should I invest the money immediately (lump sum) or gradually over time (dollar cost averaging)?
Both can help you invest your money strategically, but it can be tricky to choose between them. This guide will walk you through everything you need to know about dollar cost averaging vs lump sum investing.
Dollar Cost Averaging
Dollar cost averaging (DCA) means investing the same amount of money at regular intervals, regardless of how the market is doing. A common example of this is when people automatically invest a portion of each paycheck into a retirement plan like a 401(k).
Pros of dollar cost averaging:
- Benefit from the natural ups and downs in the stock market by averaging your purchase price.
- Prevent the regret of investing a significant amount just before the market declines.
- Helps build consistent savings habits.
Cons of dollar cost averaging:
- Less time in the market could limit your returns.
- Consistent investing requires patience and discipline.
Lump sum means that you take all or a large portion of your cash and invest it all at once. The specific amount of money is not relevant, it’s any amount that is large given your situation.
Pros of lump sum investing:
- You’ll be invested as soon as possible.
- Take full advantage of potential market growth.
The cons of lump sum investing
- It requires a stomach for market volatility.
- It doesn’t build consistent savings habits.
What is Better?
On average, the longer you wait to invest, the worse off you will be. As the saying goes, “The best time to start was yesterday. The next best time is today”.
In the chart below you can see that in all counties lump sum investing outperformed dollar cost averaging over time. US stocks were the highest at 71%.
However, if your goal is not to maximize your returns then dollar cost averaging could be the right choice for you. This method helps you gradually increase your exposure to risk over time, which can help minimize regret and lower stress from market volatility.
There is no perfect answer for everyone. Choosing what is right for you comes down to the question of your tolerance for risk. Investing all at once gives you the higher probability of taking part in larger gains but also taking part in larger losses. Dollar cost averaging can lead to a smoother ride and give a lower probability of large losses.
Disclaimers and Sources:
Probability of lump sum investing outperforming dollar cost averaging from PWL Capital.
Stock investing includes risks, including fluctuating prices and loss or principal. This information is not intended to provide specific advice or recommendations about any stock nor is it intended to be a recommendation to buy, sell or hold any stock investment. We suggest speaking with your financial professional about your situation prior to investing.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. We suggest speaking with your financial professional about your situation prior to investing.