Lump-Sum Investing vs. Dollar-Cost Averaging: Raw Returns
In a match-up between lump-sum investing vs. dollar-cost averaging, which is the better bet?
In the first installment of our Lump-Sum Investing vs. Dollar Cost Averaging Series, we explored how to invest available cash. In particular, we asked should you invest it all right away as a lump sum, or are you better off wading in more gradually with dollar-cost averaging?
On that post, we discussed why lump-sum investing is generally expected to generate the highest returns over time. In markets that have risen more, and more often than they have fallen, the sooner you deploy your investable assets, the more time they have to grow.
That said, general rules do not always apply to you. Let’s look at when dollar-cost averaging may be preferred after all.
First, it is important to emphasize:
No matter which way you go (lump sum vs. dollar-cost averaging), it is unlikely to matter nearly as much as whether you invest efficiently to begin with.
By this, we mean:
1. Planning: Start with an investment plan that reflects your personal goals and risk tolerances.
2. Investing: Invest according to your plan in a balanced mix of low-cost, globally diversified index or index-like funds.
3. Staying the course: Stick to your investments over time and through various conditions.
If you can do all that, exactly how and when you add new money is less significant. The best approach for you is the one that helps you best adhere to these sensible investment practices.
So, next, let’s turn away from theoretical returns and toward the main event: You.
Behavioral finance informs us, we are all subject to cognitive biases that subconsciously influence our decisions. As such, even if a strategy returns X% over Y amount of time, you are unlikely to receive those returns if the strategy is not a good fit for your circumstances.
Let’s illustrate. Imagine you received $24,000 to invest in early March 2020, just as the COVID-19 pandemic took off, and markets were beginning to falter. If you had decided to invest your lump sum right away, you would have had to soon watch it plummet amidst popular press outcries about “the fastest bear market ever,” “the worst first quarter in history,” and “the most volatile month on record.”
It just so happens, you would have come out okay had you stuck with it through the next two quarters. But nobody knew that at the time that things could have easily gotten worse instead.
Either way, would you really have been able to stay the course with a March 1 lump sum decision? Or would you have leaped back out? Or maybe never jumped in to begin with? If you had decided to wait until the market seemed more stable, you would probably still be waiting.
If fully investing in early March would have been too daunting, dollar-cost averaging might have been better than waiting for an “all clear” signal that has yet to arrive. By setting up an automatic schedule for dripping your $24,000 into the market over time, you could have benefitted from some of the market recovery that has taken place, while shielding some of your wealth had the market instead continued to decline.
In short, lump-sum investing is generally expected to deliver better long-term returns if you are willing and able to stick with the strategy. But dollar-cost averaging may be the better choice if a more cautious (but still brave!) approach helps you better adhere to the larger, more important tenets of efficient investing.
So, how do you decide? That is where our team at Shore Point Advisors can help you objectively assess the personal and financial trade-offs involved based on the best information available at the time. We can then help you stick to your well-devised plans over time and through life’s uncertainties.
By choosing the investment strategy that makes the most sense for you and your temperament, you stand the best chance of achieving your financial goals, no matter what the markets have in store for us next.
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.
In a match-up between lump-sum investing vs. dollar-cost averaging, which is the better bet?
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