So Whats The Difference?
Dollar Cost Averaging (DCA) and Lump Sum Investing are two ways investors may consider deploying their cash into equities if they have a large sum of cash they want to invest. So what is best? Dollar Cost Averaging vs Lump Sum Investment?
Lump sum investing as the name suggests involves simply investing the entire sum of cash at one point in time. Dollar cost averaging is the act of investing a small proportion of the cash at regular intervals over a period of time. The investor will stick to their set proportion and time frame, meaning they are to purchase regardless of the equity price. As such the investor will purchase more units when the price is low and less as the price is high and will capture an average cost basis over the period. This method may be used as a strategy of mitigating market fluctuations. It also eases the work of attempting to time the market.
Both are methods for investing capital into singles stocks as well as ETFs.
So Whats Best? Dollar Cost Averaging or Lump Sum Investment?
What is Dollar Cost Averaging?
Let’s see how dollar cost averaging works in an example.
Say you wanted to invest $20K into equities. Using a dollar cost averaging method, you would choose a timeframe to invest this amount over, say maybe 1 year. You would then select the intervals between each purchase, say every quarter. So, you would then take $20,000 and invest it over 4 periods in $5K sums every quarter (January, April, July, October) over the course of a year. The dates and amounts are calculated in advance and completely removes the pressure of attempting to time the market. Here’s a dollar cost averaging calculator.
Which is Better: Dollar Cost Averaging VS Lump Sum?
Research has shown that lump sum investing is almost always the slightly better option. Even in poorer market conditions. Here’s our breakdown;
From this graph we compare dollar cost averaging vs lump sum investing over a range of time frames and market conditions: Bullish to Bearish ranked 1-10. From this we can see that over longer periods the percentage of Dollar Cost Averaging strategies that outperform lump sum investing decreases rapidly. We also see that for the majority of market conditions Lump sum investing is better. When it comes down to Dollar Cost Averaging Vs Lump Sum Investing: LSI wins 65% if the time by an average outperformance of 1.45%
Not because of the ability to time the market, but because this option allows your money to be in the market for longer. Since the market’s expected return is positive delaying parts of your investment will forgo some returns.
“Time in the market is better than timing the market”
However, both options are decent and DCA has a strong psychological advantage. There is no need for the psychological challenge of attempting to time the market. It is a complete non-emotional approach that may be easier to stick to. It can also help investors feel safer as they can be sure they are not investing a large sum right before a market crash.
So What’s Best? Dollar Cost Averaging vs Lump Sum Investment? Both have their pros and cons. We can clearly see that the maths works out in favor of Lump Sum Investing. However, Dollar Cost Averaging has a massive psychological advantage for most people.
Most importantly actually investing is by far the best option, so which ever option helps you to get into the market is a sensible choice.