Lump-Sum Investing vs. Dollar-Cost Averaging Round 1: Raw Returns
Our investment consultants were excited to attend the recent 2021 Minnesota Financial Planning Association annual meeting. One of the highlights of this conference was hearing the financial outlook from a panel of economists. One interesting point made in the presentation was that national personal savings rates are near all-time highs. Of course, we have heard and seen this anecdotally from our clients. Part of the reason for this may be due from the pandemic. It’s hard to spend money if you can’t go out and eat at your favorite restaurant or make purchases because of supply chain issues.
With this extra cash on hand, one question we often hear is, “should I invest cash now with the market being so high?” We think this is a great question. While our long-term market outlook is positive, we wouldn’t be surprised to see market corrections along the way. Nobody enjoys seeing the market take a dive shortly after they jump in. Unfortunately, we never know when it might do exactly that.
What’s an investor to do? Should you go ahead and invest the entire amount right away? An alternative to investing the whole amount is investing 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’s often described as “plunging” vs. “wading” into the deep end of the market.
Which one should you use? In terms of raw expected returns, the academic research suggests lump-sum investing is preferred. But sometimes, there are equally valid, if less tangible reasons to favor dollar-cost averaging. In this two-part series, we’ll explore both possibilities.