Lump sum investing versus dollar averaging

The table below shows the distribution of the historical cumulative total return difference and outperformance probability between and LSI and DCA implementation over the year analysis period. Observations where lump-sum investing outperforms are associated with markets that trended higher over time while dollar-cost averaging outperformed when the implementation occurred during markets that were trending lower. Historically, there are more years where markets trend higher, which also leads to lump-sum investing outperforming.

Essentially, the data support the adage: Time in the market beats timing the market. Investing that windfall immediately allows an investor to capture returns with all of their capital at the outset versus a spread-out approach that dollar-cost averaging utilizes. In that case, dollar-cost averaging might be a more comfortable way to take investing action. Dollar-cost averaging remains a solid strategy for consistently investing small amounts of money — like a portion from each paycheck going toward retirement.

Dollar-cost averaging ensures a small amount of cash that's coming in the door is immediately invested in markets to capture potential long-term upside. Choosing dollar-cost averaging vs. Still, if markets make you nervous, it is much better to dollar-cost average and acquaint yourself with market risk over time rather than avoid markets altogether.

This index is unmanaged and cannot be invested in directly. Rolling returns, also known as "rolling period returns" or "rolling time periods," are annualized average returns for a period, ending with the listed year. All investments carry some level of risk including the potential loss of all money invested. Furthermore, DCA allows you to do the opposite of another controversial element of investment-market timing.

If an investor considered investing a lump sum from an inheritance, for example, and the market looked overheated or precarious for any reason, it may be prudent to drip feed into stocks. They say that it by no means guarantees better returns than lump-sum investments. Furthermore, they stress that investors are not always protected effectively against volatile and falling markets. After all, investors who started their regular payments in had a pretty bad time until They would have kicked off with a downhill run and the odds are they would eventually have bailed out in panic during the dotcom bear market.

Some observers point out that in a long sideways or downwards market, DCA does not differ much from a buy-and-hold strategy. Even more skeptical commentators argue that at its worst, DCA is little more than a marketing trick to convince people to hand over money regularly, ensuring trading commissions. Regular investing can be a lot better than no investing at all.

This would be wonderful, but the world of money is full of tradeoffs, and it would seem more likely to be one benefit or the other, rather than both. DCA has tended to reduce risk, but frequently at the expense of return. Dollar-cost averaging is not an investment technique for all seasons. If you get the season right, you can win both ways, but, as we know, not only does winter inevitably arrive, but the summertime blues can intervene long before that.

DCA is neither as effective as the personal finance literature claims, nor as sub-optimal as the academic literature claims. DCA vs. It certainly makes sense to look carefully at the current market conditions. On the other hand, many DCA users fail to monitor their investments after they start.

So part of the problem is not DCA itself, but the fact that other investment issues still need to be considered. It certainly does not work well in all market situations. Furthermore, research in the area indicates that lump-sum investing has tended to perform better over the longer term.

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The longer you wait, the worse off you will be, on average. The data I will present later in this post will illustrate this clearly. The next best time is today. If you grasp this concept, then the rest of this post will flow much more easily. For now, we will assume a 24 month 2 year buying window for DCA.

If you want to average in over a shorter buying window i. DCA over 12 months , assume that the underperformance will be less severe than what is shown here, and if you want to average in over a longer buying window i. DCA over 36 months , assume that the underperformance will be more severe than what is shown here.

We can extend this analysis back to using the Shiller data and we would see similar results: The only times when DCA beats LS is when the market crashes i. This is true because DCA buys into a falling market, and, thus, gets a lower average price than a lump sum investment would. So, if you picked a random month to start averaging into an asset, you are very likely to underperform a similar LS investment and by a decent amount too.

We will dive into risk more in the next section, but think about how this table emphasizes the main point from our earlier thought experiment. If an asset class is going to rise over the long run and most asset classes have historically you should buy before that rise occurs LS instead of while that rise is occurring DCA.

What About Risk? I know what some of you are thinking. They care about risk too. Stocks since illustrates: As you can see, the standard deviation of LS is much higher than DCA in every period tested this is also true for other asset classes. This is true because LS invests right away and gets full asset class exposure, unlike DCA which is always partially in cash throughout the buying period.

However, as I have addressed in a previous post , LS can still outperform DCA while using a similar or lower risk portfolio. As mentioned in the previous section, for most asset classes across most time periods, LS outperforms even on a risk-adjusted basis. Every backtest I have shown thus far has assumed that the DCA cash on the sidelines is just that—cash.

However, after my prior post on lump sum investing , lots of individuals cried out that this side cash should be invested in Treasury Bills while the DCA strategy gets invested. I know this anecdotally from speaking with many advisors at my firm who have had countless conversations with prospective clients who have been in cash for years. And if we go back further in time, the cash allocation is even higher.

More importantly though, the average Sharpe ratio of DCA is now generally higher than the Sharpe ratio for LS for nearly all but one of the asset classes tested hint: Bitcoin. So, if you are a disciplined investor who can DCA into a falling market while keeping your sideline cash invested in Treasury Bills or an equivalent T-Bill index , than you might just be better off than doing a Lump Sum investment.

Note Lump-sum investing is a riskier investment strategy but also has the potential for much higher returns. When you invest all your money at once, you immediately get full exposure to market growth or decline. However, the contrary is also true. Price Per Share When you make scheduled investments regardless of current economic conditions, you will likely buy more shares when prices are low and fewer when prices are high. When averaged out, your price per share may turn out to be much lower than if you tried to pick the optimal price and invested your money all at once.

Special Considerations Keep in mind that when following a dollar-cost averaging strategy, you are not avoiding market loss and may be forgoing potential returns at the cost of lower risk. Note When lump-sum investing, you are not guaranteed higher returns and are exposing yourself to greater market risk.

Depending on the type of investment purchase, keep in mind that you may pay more brokerage fees overall with dollar-cost averaging because you are making multiple purchases, rather than a single lump-sum purchase. Dollar-Cost Averaging vs.

Here is a hypothetical example of each scenario. This is an example of lump-sum investing.

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