Lump Sum Versus Dollar Cost Averaging Investing
Most people do not think twice about the timing of making contributions to a 401(k) plan that is automatically deducted from their paychecks. However, people who are in a situation of having extra cash on hand tend to struggle with the timing of putting the money to work in the market on their own. The dilemma of investing it all at once as a lump sum or dollar cost averaging (systematic investing over a period of time) can translate into procrastination. And, failing to act is a less favorable outcome than both of the options being considered when investing for the long-term.
There is no perfect way to make this decision because predicting short-term movements of markets is not easy. While the near future in markets is unknown, the math in making this decision supports lump-sum investing. Over time, markets tend to increase in value making it a better decision to invest your money all at once. A Vanguard study confirmed this by using historical return data from 1926-2015 and comparing lump sum investing a 60% stock / 40% bond portfolio versus systematically dollar cost averaging it over a 12-month period. The study found that lump sum investing was better 68% of the time and had average out-performance of 2.39%.
While studies support lump sum investing, it tends to be emotionally difficult for many investors, especially during periods of uncertainty or increased market volatility. This is unfortunate, because volatile periods (like March 2020) can present opportunities for lump sum investing to be even more successful. Market timing is difficult and investors can rarely pick the exact bottom. However, when investing for the long-term, you do not need to time the bottom to come out ahead. A good practice is to develop an action plan, write it down, and stick with it.
Whether it is lump sum investing or dollar cost averaging over time, having a plan and working with a qualified advisor will lessen the emotional burden of investing large sums of money. Contact us today for help deciding how to invest your extra cash.