The Power of Human Ingenuity
Market performance in 2024 reflected the power of human ingenuity, which kept the economic engine going.
Good news. You have an extra $24,000, and you have decided to invest it in the stock market. It is always nice to have investable cash on hand. But you also might feel as if the pressure is on. Nobody enjoys seeing the market take a dive shortly after they jump in. Unfortunately, we never know when it might do exactly that.
What is an investor to do? Should you go ahead and invest the entire amount right away, or should you invest gradually, such as in 12 monthly installments?
In financial jargon, this is known as lump-sum investing (all at once) vs. dollar-cost averaging (over time). In more approachable terms, it is often described as “plunging” vs. “wading” into the deep end of the market.
Which one should you use? In terms of raw expected returns, lump-sum investing is preferred. But sometimes, there are equally valid (albeit less tangible reasons) to favor dollar-cost averaging. In this two-part series, we will explore both possibilities.
In a match-up between lump-sum investing vs. dollar-cost averaging, which is the better bet? Everyone from academics to financial practitioners and the financial press have weighed in on the matter, and they have reached a consistent conclusion:
Lump-sum investing generally improves your odds for earning higher returns compared to dollar-cost averaging.
For example:
Who is more likely (although not guaranteed) to come out ahead? Tom’s lump sum has a better chance of generating more wealth than Kevin’s dollar-cost averaging.
This general expectation is well-established in academia, at least as far back as a landmark study published by George Constantinides in a 1979 Journal of Financial and Qualitative Analysis. Others have expanded on the theme ever since, examining nuances such as:
So far, our general rule of thumb holds. Even without academic analysis, this makes sense:
When markets rise, lump-sum investing bests dollar-cost averaging: If you invest everything up front, more of your money has more time to compound in a rising market than if you have dripped it in more slowly. Of course, the reverse is also true. If markets go down, your bigger, earlier stake takes a bigger hit. But…
Overall and over time, markets go up higher and more often than they go down: For example, if you look at historical returns for the S&P 500 by year, you will see they have varied widely. Despite setbacks along the way, the market has prevailed, delivering nearly 10% per year on average from 1928–2023.
Therefore, it stands to reason: If lump-sum investing outperforms dollar-cost averaging in up markets, and markets go up more, and more often than they go down…
When the choice is available, a purely rational investor should generally prefer lump-sum investing to dollar-cost averaging.
That said, we humans love to wonder whether generalities apply to us. What if you are not yet convinced a lump-sum investment makes sense for you, your personal circumstances, and the latest market conditions?
This brings us to round two of our match-up between lump-sum investing vs. dollar-cost averaging. We will share those results in the second and final installment of this series. The winner has yet to be declared.
This post was written and first distributed by The Writing Company.
DISCLAIMERS
This material is intended for general public use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact one of our financial professionals for guidance and information specific to your individual situation. This is not an offer to buy or sell a security.
Shore Point Advisors is an investment adviser located in Brielle, New Jersey. Shore Point Advisors is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Shore Point Advisors only transacts business in states in which it is properly registered or is excluded or exempted from registration. Insurance products and services are offered through JCL Financial, LLC (“JCL”). Shore Point Advisors and JCL are affiliated entities.
Market performance in 2024 reflected the power of human ingenuity, which kept the economic engine going.
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One concern about the increasing popularity of index funds is whether the decline in active management has impacted the function of markets.