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Lump-Sum or Dollar-Cost-Averaging #InvestmentTips #Invest #MoneyTips

Dollar Cost Averaging vs Lump Sum Investing

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Invest Now, or Temporarily Hold Cash?

With markets near all-time highs, one question often asked by investors is: should I invest now or wait for a correction?

Every investor wants to be able to time the stock market perfectly, buying low and then selling high. Therefore maximizing profit, and avoiding paying too much for stocks, bonds or any other asset. Unfortunately, this is easier said than done.

Lump-Sum or Dollar-Cost-Averaging #InvestmentTips #Invest #MoneyTips

What is Dollar Cost Averaging (DCA)?

Dollar-cost averaging (DCA) is when you buy a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. Thus buying more when the price is low, and less when the price is high.

This investment technique is an alternative to making an investment as a lump sum.

What is Lump Sum Investing (LSI)?

This is when you invest all your money at once.

The lump-sum investing approach vs. dollar-cost averaging

When you have a good amount of savings and want to invest, here’s the question you face: Should you invest it all right away (lump-sum) or in smaller increments over time (dollar-cost averaging)?

If you look it up you will find a lot of studies, such as this one, that will highlight a good point in terms of return: LSI will have a higher probability of superior returns than using the DCA technique.

With this vanguard study, if you start with 1 Million dollars (holding period of 10 years), in the United States, the 12-month DCA led to an average ending portfolio value of $2,395,824, while LSI led to an average ending value of $2,450,264, or 2.3% more. Also, they did the same study for Australia and UK: the results were similar.

Having all this information into consideration, why would someone even consider DCA?

How to invest a lump sum of money

Although research indicates that it’s prudent to invest a lump sum immediately, there are other factors to take into consideration, namely your risk tolerance and/or if your top priority is to cut the downside risk.

Lump-Sum or Dollar-Cost-Averaging #InvestmentTips #Invest #MoneyTips

Only you reader know your risk tolerance and priorities, so only you can decide according to those factors.

Personally, if I were a conservative investor with a low-risk tolerance, my investment plan would be:

  1. Set the desired allocation between assets. Let’s say 60% stocks and 40% bonds.
  2. Create a program for the amount that I have saved and want to invest. For example, divide that amount between the next 12 months, and invest every single month until the end of that year. This requires discipline. So if I have $12,000, I would divide into 12 monthly installments (12 x $1,000) and then invest $1,000 every month. For 12 months.

Another possibility:

  1. Set the desired allocation between assets. Let’s say 60% stocks and 40% bonds.
  2. Invest all the cash in the (expected) less volatile asset, in this case, bonds. And then gradually within the 12 months start to invest in stocks until I reach the desired target asset allocation.

How about you reader? Do you think an investor should be all-in, or gradually incrementing its position? What would you do if you received a huge amount of money to invest? 

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2 thoughts on “Dollar Cost Averaging vs Lump Sum Investing

  1. Hi Joao,

    First of all, many thanks for popping by my site & for your comment, I thought I’d check yours out in return & your site looks good.

    I’m a little confused by this comment: “Dollar-cost averaging (DCA) is when you buy a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. Thus buying more when the price is low, and less when the price is high.”

    i.e. if you are buying a fixed dollar amount on a regular schedule – i.e. you have basically automated your investment building up your investment over time, this does not necessarily imply that you buy more when the price is low and less when the price is high, does it?

    It does cushion you from making a lump sum investment at the wrong time and losing a lot of money at the worst point possible but if that investment decreases in value over time then you would have bought more when the price is high and less when the price is low, wouldn’t you?

    Unless I’m missing something…

    best wishes,
    Alan

    1. Hello Alan,

      If I plan to buy $1000 per month of the share A regardless of the price this is what could happen:
      Month 1:
      Share Price of the ETF GrowtoRetire.com = 10$
      I will buy 100 shares. (100 shares x $10 = $1000)
      Month 2:
      Share Price of the ETF GrowtoRetire.com goes up to $100
      With the same amount of money ($1000) I will buy only 10 shares (thus I’m buying fewer shares…precisely when they are MORE expensive…GOOD!)
      Month 3:
      Share Price of the ETF GrowtoRetire.com goes down to $1
      With the $1000 of this month I will buy 1000 shares of the ETF!!! (Therefore buying a lot more shares…precisely when they are cheaper…GOOD!)

      Conclusion: I have now 1110 Shares (100 + 10 + 1000). But 1000 of all those shares were bought when they were cheaper ($1 per share) compared with other months.

      In the scenario where the “investment decreases in value over time”, DCA enables you to buy more shares for the same amount of $$$.
      On the other hand, in the scenario where “investment increases in value over time”, the lump sum strategy will clearly outperform the DCA strategy. Because you will (probably) have a superior return when compared with cash.

      Regards,
      [email protected]

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