Is It Better to Invest a Lump Sum of Money or Dollar Cost Average?

From MarketWatch (emphasis added):

The computer simulations were based on market returns for rolling 10-year periods starting in February 1926 and ending in December 2011. In addition to the U.S., the researchers looked at the same periods for the U.K. and Australia.

The results: Those who took a year to fully invest lagged investors who went all-in about two-thirds of the time. People who took more time faced even longer odds. Perhaps surprisingly, it didn’t make any difference whether investors picked an aggressive portfolio made up entirely of stocks, a mix of stocks and bonds, or a conservative portfolio made up entirely of bonds.

In dollar terms the discrepancies could be significant: a $1 million portfolio invested all at once in a mix of 60% stocks and 40% bonds turned into $2,450,264 on average, compared to $2,395,824 when the same U.S. securities were bought over the course of a year, a difference of more than $54,000.

Why does the all-in strategy have an edge? “Markets historically have gone up more than they have gone down,” said Vanguard principal Daniel Wallick.

Even if dollar-cost averaging doesn’t usually produce the greatest returns, the worst case for most small investors isn’t failing to put their money into the market all at once, experts say. It’s failing to do simple things like saving enough for retirement or panic selling when the market crashes. It’s a point that can easily get lost.

The results of the study make sense for the reason quoted by Mr. Wallick:   “Markets historically have gone up more than they have gone down”.  And that’s true over the very long term of the study.  But there are long stretches of years of secular bear markets, such as 1929 to 1941, 1969 to 1982, and 2000 to possibly present, during which dollar cost averaging works better than investing in a lump sum.  Conversely, during secular bull markets it makes more sense to invest in a lump sum instead of dollar cost averaging.  Of course, it is difficult if not impossible to know in real time when secular bull and bear markets begin and end.  Few people if any can definitively state that the secular bear market that commenced in 2000 ended in 2009 or is still intact.

But the article misses the main idea about dollar cost averaging.  Secular bull or bear, dollar cost averaging is a risk management tool.  And certainly for large amounts of money, management of risks should take precedence over management of returns.  Successful long term investing is about optimizing returns, not maximizing returns.  Using the numbers cited in the article, the $54,000 difference from $2,395,824 is less than 2.3% spread out over ten years.  Not to be cavalier about investment returns, but contrary to what the article states this is NOT a significant amount over the long term that warrants disregarding risk.  That amount of money in relation to the ultimate size of the portfolio should not make a difference in one’s lifestyle, or if it does we have to wonder about their priorities of simply wanting more, more, more.

The most important point of the article is that “for most small investors … failing to do simple things like saving enough for retirement or panic selling when the market crashes” has a far bigger impact on their long term investment results than how they invest a lump sum.

Source:  Investing a lump sum of money in stocks pays off


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