Top 10 Question: Dollar Cost Averaging or Lump Sum?
If you have a 401k, 403b, or some other retirement plan account at work then you already are using this technique to invest in the stock and bond markets. Putting in money to your retirement account from each paycheck is the classic dollar-cost averaging tool.
The Dollar Cost Averaging vs Lump Sum question usually comes up when someone receives or inherits a large sum of money to be used for long-term investment purposes. It is a very frequent question, probably a top ten financial question, in my opinion.
There is plenty of research on this topic/question. The latest study comes from Northwestern Mutual, a life insurance and investment company.
This 2021 NW Mutual study featured different stock to bond allocations and different rolling ten-year time periods beginning in 1950 to the present day. The bottom-line conclusion was lump sum outperformed dollar-cost averaging 75% of the time regardless of the asset allocation of stocks and bonds.
There are several factors that might keep you from investing all your money at one time.
- Timing the market – you get a feeling the markets are about to go down and you want to wait until you feel it’s about to go back up. Most people wait too long using this approach.
- Past experience – The last time you invested a large sum, the market went down right after you did that. People just keep waiting and nothing happens until it’s obvious it’s too late but that experience keeps them frozen.
- The press or pundits say the market is “overvalued”. By the time most articles say the worst is over it turns out historically to be too late.
- Timeline – The need to use this money for another purpose sooner (say 3-5 years) rather than long-term investing can inhibit people from putting the whole enchilada to work immediately. Risk of loss is higher for time periods less than ten years, even in a diversified portfolio.
The ultimate answer to the question of DCS vs LS, is “it depends” on your time horizon. Over ten years, the odds are way in your favor for lump sum to avoid the risk of waiting too long or not investing at all. After a few years, you’ll know lump sum was the right decision.