Tax Considerations for 2024: What You Need to Know Before Filing
Tax season is not the most joyful time of year, but it is certainly one of the most important.
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.
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