Investing a lump sum vs. dollar cost averaging

Despite the odd blip over the last decade, Canadian and U.S. stocks continue to reach all-time highs. Investors are understandably worried about the next correction or crash. In particular, investors who are sitting on large amounts of cash are nervous about deploying their capital at today’s frothy valuations.

Research has shown that, since stocks are up 70-75 percent of the time, it’s best to invest the entire lump sum all at once rather than dollar-cost-averaging your way into the market over time. Even worse is trying to time the market by waiting for a crash that may never come and missing out on gains along the way.

Related: When is the best time to invest?

A Vanguard paper released several years ago looked at data from the U.S., United Kingdom and Australia and compared the results of investing a $1 million lump sum with using dollar-cost-averaging (DCA) over 12 months.

“In all three countries, over rolling 10-year periods, the lump-sum strategy came out ahead almost exactly two-thirds of the time for a portfolio of 60% equities and 40% bonds. They also ran the numbers using DCA periods from six to 36 months, and various mixes of stocks and bonds, with similar results.”

But, you say, this time is different. The markets have been on a 10-year run, which can’t last forever. Plus, TRUMP! Surely, it’s better to wait for a market pullback before putting our cash to work.

Investing a lump sum in 2007

Let’s go back in time to October 11, 2007. The S&P 500 closed at an all-time high of 1,562. A year later, on October 9, 2008, it closed at 899. The bottom of this historic crash wasn’t hit until March 5, 2009 when the S&P 500 closed at 683.

Had you invested a $100,000 lump sum on October 11, 2007 there’s no doubt you’d be filled with regret over the awful timing of your investment, which had lost 56 percent of its value. Indeed, it would take until March 18, 2013 – some five-and-a-half years later – for your original investment to finally reach a positive return.

The S&P 500 reached another all-time high on April 30, 2019, closing at 2,946. If you managed to hold on to that investment without panicking, you would have seen a compound annual growth rate of 5.94 percent since that fateful October day in 2007

Even with the worst possible timing in the world, investing a lump sum just before one of the biggest stock market crashes in history, you would have been okay had you held course.

Final thoughts

I like to put my money to work in the market right away and so if I find myself with a substantial amount of cash from a contribution then I use my long-term asset allocation as a guideline and invest the entire amount at once. That means ignoring market noise and suppressing my own instinctive fear of the unknown. It’s not easy.

Related: How investors can control their urgency instinct

For investors who simply can’t suppress their anxiety over investing a lump sum all at once, I recommend setting up a pre-determined schedule to dollar-cost-average your way into the market.

For example, if you have $100,000 to invest then put $25,000 to work right away, then another $25,000 on the same day three months from now, and so on until it’s fully invested over a 12-month period.

Investing a lump sum may be the more optimal choice but if the fear of regret is so strong that you won’t be able to sleep at night then dollar cost averaging might be a better fit from a behavioural standpoint.

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7 Comments

  1. Karl B. on May 31, 2019 at 5:08 am

    Psychology will negatively play against DCA for most people. If you think markets are at all-time highs and are afraid to invest right now, what are you going to do in 3 months when markets are even higher? Or *gasp*, when markets went down because of Trump, Brexit, tarrifs, Greece, China, Middle East conflicts, etc.? You’re essentially splitting one tough decision into several. Now, that being said, most people can (and should) actually do DCA by contributing every two weeks (or twice a month or monthly) when they get their paycheck.

  2. Shawn Vincent Benjamin on May 31, 2019 at 8:06 am

    I am somewhat perplexed why many of these Financial Institutions recommend not to time the market especially when they do this themselves and make a killing at doing it. They just do not want others getting in on the action. Of course, there are many ways of reaching this objective like have extra cash available while still Dollar Averaging.

  3. Robert Gignac on May 31, 2019 at 10:53 am

    Perhaps the bigger issue for most is they don’t have the lump sum. Sure, putting $10,000 in once vs. $250/month for 40 months works out better mathematically, but if you wait the 40 months until you save the $10,000 to drop it in – what did you lose by not having any of that money invested during the previous 3.3 years? For many people, DCA is the easiest strategy to follow month after month after month… as Ron Popeil used to say all the time in the Ronco Rotisserie informercial…. “set it, and forget it”

    • Sarah on June 8, 2019 at 8:16 am

      I think he is referencing when you have a large sum to invest (inheritance, sale of a home, moving from GICS or something into the market). Robb is a strong advocate of regular, scheduled contributions which DCA over the year, from my reading experience on Boomer & Echo.

      We experienced the article’s exact quandary when we chose to take a large piece of our portfolio out of a big bank – we sat with over $100k in our account and really struggled with the idea of just plopping into the market in one moment (a high moment IMO) vs slowly buying. We chose to invest the lump sum….and watched the market climb higher and higher for two years after that.

  4. Kevin on May 31, 2019 at 11:32 am

    Funny timing for this article. We’ll have a period of about 5-6 months (or less) between selling our house, and completing a 20% down payment on a new build. Where should our equity from the sale be parked for this duration? High interest savings account through Tangerine, or equivalent? A low risk TFSA investment (we have room)? Put it all on black? Decisions to make..

    • Mathieu on June 3, 2019 at 9:06 pm

      Hi Kevin,

      I would not put my money in the Stock Market for a short period like that. I think that a high interest savings account would be the best for you. You can get around 2.3% if you shop wisely (alterna bank in my case). Tangerine is good if there is a special offer, but otherwise, their base rate is too low.

      Good luck!

  5. Garth on June 6, 2019 at 11:32 am

    Nick Maggiulli did a nice piece on this topic…

    https://ofdollarsanddata.com/how-to-invest-a-lump-sum/

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