What is Dollar Cost Averaging? What is Lump Sum Investing?

If you stumble across $100,000 (for whatever reason) and you decide to invest that money, should you invest it all at once or spread your contributions out? The first step is to let me know where you found the money so I can find some for myself.

Dollar-cost averaging (DCA) is an investment strategy where you divide the total amount of money you have available to invest into smaller payments that you make over time. If you wanted to invest that $100,000 over ten months, you would divide $100,000 by ten and consistently invest the resulting $10,000 every month, ignoring what the market is doing.

The alternative to dollar-cost averaging is called lump-sum investing (LSI). Lump-sum investing would involve investing all $100,000 at one time instead of spreading out your contributions.

So which one is better?

If you can only remember one thing from this letter, please remember this: total time in the market is more important than when you joined the market.

Historically, the best time to invest your money is as soon as possible. Why? Because the market goes up more often than not, so $10 today is likely (but not guaranteed) to buy you more shares than $10 next week.

Lump-sum investing results in a higher probability of better returns than dollar-cost averaging since the market has historically trended upward more often than it has trended downward. A 2012 study by Vanguard comparing DCA and LSI strategies found that LSI outperformed DCA roughly two-thirds (67%) of the time over rolling 10-year periods since 1926.

LSI favors a rising market, since you’re investing when shares are cheaper and your invested money increases in value as the market goes up. The downside to LSI is if you may be part of the 33%, investing all of your money at a market high and watching it promptly drop in value.

DCA favors investors during a declining market since their contributions will be buying cheaper and cheaper shares as the market goes down. It’s like winning the lottery when the thing you’ve been eyeing on Amazon randomly goes on discount.

So if we’re looking purely at the nerd side of the equation (statistics, math, and history), lump-sum is the way to go.

However, there is something to be said about the psychological aspect of each strategy. For investors with a lower tolerance for volatility, dollar-cost averaging into the market may help you feel more at ease when investing large sums of money. In turn, this may help you keep your cool during market volatility and reduce the risk of panic-selling or market timing attempts.

If you're hyper-concerned about avoiding losses over maximizing returns, I would first encourage you to look at the historical overperformance of LSI and ask you to reconsider. If that still doesn't ease your concerns, choose DCA to encourage you to continually invest through any potential market volatility. DCA isn't the wrong option per se, but you're likely reducing your chance of greater gains. Even if it feels like the market is spiraling and DCA is the best move, your market speculation may very well turn out to be incorrect (ask anyone who thought the market would continue to plummet in March 2020 after the COVID-19 market crash).

If you choose to DCA a stockpile of money, don't spread out your contributions over more than one year. Practically speaking, don't divide the total amount of money you plan to invest by any number greater than 12 (reflecting the 12 months of the year). A three-month DCA period has a higher probability of outperforming money invested over six months, which will likely beat nine months, and so on. Money sitting out of the market for more than a year with no specific savings goal or plan is losing value to inflation.

How to invest on a regular basis

Now, everything I’ve covered so far applies specifically to piles of money you have ready to invest. This isn't a common occurrence unless you're a regular lottery winner or written into several wills (if so, good on you/sorry for your loss). When investing money from your regular income, I'll reiterate my original statement: the best time to invest your money is as soon as possible. Saving up money in a bank account to later invest it in a single lump sum defeats the purpose.

I recommend contributing to your investment accounts at least monthly and no more than twice monthly. Don't stockpile money until the end of the year before investing it. This defeats the purpose of LSI. Put your planned contribution amount in the market each month to get your money in the game and let compound interest do its thing.

If you have a 401(k) or similar employer-sponsored retirement plan, spread out your 401(k) contributions throughout the year to receive the matching benefits from your employer every month, if applicable. If you plan on maxing your 401(k) contributions in 2023 with a limit of $22,500, divide $22,500 by 12 ($1,875) and contribute the percentage of your income that equals $1,875 each month. Another benefit of the 401(k) is that your employer matching does not go against your yearly contribution limit. Spreading out your 401(k)/TSP contributions throughout the year ensures you receive the match every month from your employer, rather than hitting your contribution limit halfway through the year and missing the additional money your employer owes you.

Call to Action

Do you have a stash of money that you want to invest? Figure out where to invest it (start here and here) and either invest in a lump-sum or make your first dollar-cost averaging contribution.

What We’re Reading/Listening To:

Playlist: REVAMPED by Demi Lovato. Thought “Heart Attack” by Demi Lovato was good? Try listening to the rock version, it makes me feel like an angsty teen.

Debrief on Deck

Next week, we’re going to interview a real-life investment advisor! If you’ve been around here for a minute, you know my (Mike’s) stance on having other people invest your money for you. But we’re going to show you the other side of the coin so we’re being fair and hearing both sides of the story.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (X (formerly Twitter) and Instagram).

Until then, stay the course.

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