Dollar Cost Averaging vs. Lump Sum Investing: Which Is Right for You?
When it comes to investing, there are all types of theories and strategies. One of the most debated is whether you should invest all of your money right away when you get it, or spread out your investments over time. Dollar cost averaging refers to making regular investments over time, whereas lump-sum investing involves putting all your money in the market right away. But beyond these broad characteristics, what are the benefits and drawbacks of dollar cost averaging and lump sum investing? Here’s a quick overview of the main distinctions between the two.
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Dollar Cost Averaging
Dollar cost averaging refers to investing your money at regular intervals, regardless of how the market is doing. Most investors find it easiest to dollar cost average by setting up automatic transfers from their bank account into their investment account. Here are the main pros and cons of dollar cost averaging.
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Gives You an Average Price
One of the prime benefits of dollar cost averaging is that you end up with an average price for the stocks you buy. By definition, this means that you’ll never buy at the peak of the market, and over the long run, you can expect an average-type return. The downside, of course, is that this means your average price will never be at the market lows, as over time you’ll buy shares at both the market highs and market lows.
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You’ll Buy More Shares When the Market Is Low
You won’t get all your shares at market lows when your dollar cost average, but you will get some. And if you’re investing the same amount at regular intervals, this means you’ll end up buying more shares when the market is low, and fewer shares when the market is high.
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Encourages Consistent Investing
To properly dollar cost average, you’ll have to invest at regular intervals. Whether you set up automatic transfers into your investment account or physically invest the money yourself, you’ll be constantly engaged with the market. By getting in the habit of making regular investments, it’s more likely you’ll be a consistent investor throughout your entire life.
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Lump-Sum Investing
Lump-sum investing involves putting your whole investment bankroll into the market at one time. This no-hassle approach has a lot going for it, but it also has drawbacks. Both are outlined below.
Set It and Forget It
The “one-and-done” strategy defined by lump-sum investing is appealing to investors who don’t have the time or the inclination to monitor their investments. If you put all your money in the market in one lump sum, you don’t have to worry about timing the market or setting up consistent investments. Once you buy your stocks, you know what you own and at what price, and all you have to do from then on is check your statements from time to time.
On the downside, this type of “hands-off” approach to investing means that you might miss an opportunity to add to your stocks when they trade lower.
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More Time in the Market
The market tends to go up over time, so starting as soon as possible can be a good long-term investment strategy. If you invest all your money in a single lump sum, you’ll by definition have more of your money in the market for a longer time than if you spread that investment out over months or years.
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Can Catch the Market Bottom
If you put all your money into the market at once, you might catch the market when it’s at or near its lows, thereby maximizing your long-term profits. However, that would be a true stroke of luck. You might just as easily buy into the market when it’s at its peak, which could set you up for years of below-average returns.
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Last updated: July 15, 2021
