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All In or Some In? Lump-Sum Vs. Dollar Cost Averaging

stacked poker chips with different colors

If you've procrastinated on investing and is now sitting on a big pile of cash, getting started can be pretty intimidating.

What if the market tanks right after I invest all my money? 

This is completely possible. If you invested in the S&P 500 in October 2007, at the peak price of $1,900 (right before the financial crisis), in less than 2 years, your investment would've collapsed to $900. Yikes.

So what if I don't want to go all in? 

Dollar-Cost Averaging (DCA) is a popular alternative to Lump-Sum investing. DCA is investing fixed amounts over a period of time.

If you had $12,000, instead of investing all at once, you could invest $1,000 per month over the year.

With DCA, you reduce the impact of dramatic declines. If the market crashes, you luckily only invested a small portion when the market was high, with money leftover to invest when the market is low. DCA allows you to buy less shares when markets are expensive and buy more when markets are cheaper.

Sounds like a good deal, right? Not so fast.

Lump-Sum Vs. Dollar Cost Averaging

A study by Vanguard examined rolling 10-year periods from the US (1926-2011), UK (1976-2011), and Australian markets (1982-2011). Comparing Lump-Sum to DCA, the study found that across all markets, Lump-Sum investing performed better 66% of the time.

With a 60/40 portfolio, Lump-Sum investing would've led to a 2.3% greater performance in the US markets, 2.2% in the UK, and 1.3% in Australia after 10 years.

The reason is pretty simple, cash is a terrible investment. It doesn't do much when left alone. Holding cash is very low risk, hence very low reward. Stocks have a much higher expected return, so it makes sense that being invested sooner would lead to better performance in the long run. Sitting on cash delays the power of compound interest.

Conclusion

DCA is a great way to ease into the markets if volatility is too much for you to handle. However, if you're investing for the long run, you should seriously consider Lump-Sum investing. As a long-term investor, you benefit from being able to ignore the short-term ups and downs of the market. As long as you're in a risk-appropriate portfolio, the best time to invest is now.







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