How to Invest New Cash: Dollar Cost Averaging vs. Lump Sum Investing

TL;DR

Investing a lump sum of cash immediately in a risk-appropriate portfolio is generally more beneficial than dollar cost averaging over time.

Transcript

if you're sitting on a lump sum of cash that you plan to invest you could invest the lump sum in a risk appropriate portfolio immediately you could dollar cost average over a period of time meaning systematically investing equal parts into a risk appropriate portfolio over a set period or you could sit on your cash until what feels like a good time... Read More

Key Insights

• 👍 Dollar cost averaging is a popular strategy due to its behavioral appeal, but it has been proven to be suboptimal from a rational decision-making perspective.
• 🛀 Investing a lump sum immediately in a risk-appropriate portfolio has been mathematically shown to be more advantageous than dollar cost averaging.
• ✋ Even in the worst market conditions or at market highs, investing a lump sum outperforms dollar cost averaging.
• 😘 Waiting for a market dip before investing a lump sum generally leads to lower returns and is not a reliable strategy.

Questions & Answers

Q: Why do people often choose dollar cost averaging over lump sum investing?

Dollar cost averaging is popular due to the behavioral appeal of minimizing regret and avoiding investing a lump sum right before a market crash. However, from a rational decision-making perspective, it has been proven to be suboptimal.

Q: Is there a cost associated with dollar cost averaging?

Yes, the approximate annualized cost of dollar cost averaging is about 0.38% over 10 years, which is higher than the fee on most index funds.

Q: Does dollar cost averaging perform better in the worst market conditions?

In the worst 10% of outcomes for lump sum investments, dollar cost averaging does have a small advantage on average. However, it still trails lump sums more than 50% of the time.

Q: Is waiting for a market dip before investing a lump sum beneficial?

No, waiting for a market decline to invest a lump sum, even at a 10% or 20% drop, underperforms on average and in most ten-year periods. It is generally more optimal to invest the lump sum as soon as possible.

Summary & Key Takeaways

• Investors often struggle with deciding whether to invest a lump sum or employ dollar cost averaging.

• Dollar cost averaging involves systematically investing equal parts into a risk-appropriate portfolio over a period of time.

• However, studies have shown that investing a lump sum immediately is mathematically more optimal than dollar cost averaging.