Lump Sum Or Dollar Cost Averaging?

The Best Investing Strategy!

Introduction

Have you ever asked yourself, should I invest all of my money now or just invest a little bit at a time? - Today we will find the answer based on a lot of research and data!

There are 2 main strategies when investing:

Strategy 1: Lump Sum - this is when you would invest all of your money at one point in time and continue to invest whenever you have additional money.

Example - You have $10,000 and you invest it all in one go.

Strategy 2: Dollar Cost Average (DCA) - this is when you invest a fixed amount from your pay check on a regular basis regardless of what the share price is.

Example - You invest $1,000 a month.

So which strategy has been proven to give the best return for investors?

The Answer

Lump sum investing strategies beats the typical dollar cost averaging investment two-thirds (66.6%) of the time according to both historical and simulated market data.

Dollar cost averaging can be considered to be better for those investors who are very risk averse (dislike risk) and prefer to hold a lump sum in cash.

The Data

Figure: 1

From figure 1 above we can note that:

1- Lump sum investing outperforms cost averaging 68% of the time.

2 - Cost averaging outperforms cash 69% of the time.

3 - Lump sum investing outperforms cash 70% of the time.

Please note however that this is based on historical data and that past performance is not a guarantee of future performance.

Figure: 2

From figure 2 above we can note that:

1 - Lump sum investors (100% equity) in all but the worst outcome (25th percentile) outperform those who cost average in most historical market environments.

2 - The same as above holds true if you were to invest in one lump sum but in 60% equity and 40% bonds.

3 - The same as point 1 holds true if you were to invest one lump sum in 40% equity and 60% bonds.

4 - In the majority of circumstances 100% equity outperforms the other allocations.

Best For Me?

You also have to factor in risk preference as not all investors are happy to invest all their money in one go regardless of what the historical numbers tell us.

If you are someone who wants to avoid large drawdowns are are happy to take a potentially slower path to portfolio growth then you could be described as loss averse.

Figure: 3

The box on the left is if you are happy to take on a little more risk, whereas the box on the right is if you don’t want as much risk and are happy with a potential smaller growth in the portfolio and smaller drawdowns.

From figure 3 above we can note that:

1 - If you are not loss averse you could lump sum invest unless you are a very conservative person.

2 - If you are loss averse then you could cost average unless you are an adventurous person.

Conclusion?

• In the majority of cases lump sum investing outperforms cost averaging.

• In the majority of cases lump sum investing with 100% in equity outperforms any other strategy.

• Different investor preferences will lead to different strategies regardless of what the historical data shows.

• Important to remember that past perform is not an indicator for future performance.

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Note: I am not a financial advisor or licensed professional. Nothing I say or produce anywhere, should be considered as advice. All content is for educational purposes only. I am not responsible for any financial losses or gains. Invest and trade at your own risk.

Our resource for today’s newsletter comes from Vanguard.