Happy New Year, Friends!
It’s that time of the year again when the contribution limit for our investment accounts reset. I have been asked a lot of times if it’s better to invest with DCA (Dollar Cost Average) or Lump Sum?
First of all, what is DCA? What is lump sum investing?
- DCA or Dollar Cost Averaging is allocating a set amount of money at regular intervals, usually shorter than a year (monthly or quarterly). DCA is generally used for more volatile investments such as stocks or mutual funds, rather than for bonds or CDs.
- Lump Sum Investing is investing an entire amount at one go. Lump sum amount is defined as a single complete sum of money.
Some things to consider when choosing if you should DCA or lump sum invest:
1. We can’t predict the future
No one can. People always think that they can time the market and make the best investments at the RIGHT time. That doesn’t happen. The news is often filled with market predictions but it doesn’t really tell us the future.
Even if we knew where the market would stand a year from now, we still wouldn’t know whether lump sum investing or dollar cost averaging would lead to the best result. Why? Because the outcome would depend on how the market performed during the year. If it fell and then rose, dollar cost averaging would take advantage of the lower prices. If it rose and then fell, lump sum investing would lock in the lower price at the start of the year
2. History says lump sum investing is better.
There was a study published by Vanguard in 2012 that compared lump sum investing and dollar cost averaging. Vanguard found that at the end of the 10-year period, lump sum investing beat dollar cost averaging about two thirds of the time. The results were consistent across the U.S., the United Kingdom, and Australia.
If you’re a numbers person and want to take the approach that gives you the best chance of having more money, then according to this study, lump sum investing would be your best approach.
3. Dollar cost averaging is better if you want to avoid loss
If you are more concerned about avoiding loss than maximizing returns then dollar-cost averaging may be better for you. Vanguard’s study provides insight into this perspective as well. What it found was that during a down market, dollar cost averaging resulted in losses less frequently than lump sum investing. Specifically, the study found that lump sum investing declined in value 22.4% of the time. Dollar cost averaging was down 17.6% of the time.
So if your concern is preservation of assets, dollar cost averaging might be the better approach.
Whether you dollar-cost average or lump sum invest, the difference between the two is relatively small.
So you should instead, consider your risk tolerance and always follow an investment plan.
The most important thing in investing is THAT YOU ARE INVESTING. Remember, time in the market is more crucial than timing the market.
As for me, I lump sum invest my ROTH IRA contributions at the start of the year while I DCA my investments in my individual brokerage account. The reason for this is because my retirement account is mainly invested in Index Funds which is a less volatile asset that individual stocks. My individual brokerage account, on the other hand, is invested on growth stocks and some value stocks.
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