The Disciplined Investor

Lump-Sum Investing vs. Dollar-Cost Averaging Round 2: What Makes Sense for You?

In my last piece, we explored how to invest available cash: Should you invest it all right away as a lump sum? Or are you better off wading in more gradually with dollar-cost averaging?

In round one, we discussed why lump-sum investing has historically expected to generate higher returns over time. In markets that have risen more, and more often than they’ve fallen, the sooner you deploy your investable assets, the more time they have to grow. That said, general rules don’t always apply to you. Let’s look at when dollar-cost averaging may be preferred after all.

Considering the Big Picture

First, it’s important to emphasize:

No matter which way you go (lump sum vs. dollar-cost averaging), it’s 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: Sticking 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.

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The Disciplined Investor

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.

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The Disciplined Investor

Welcome to the Disciplined Investor Blog! 

"The investor’s chief problem—and his worst enemy—is likely to be himself. In the end, how your investments behave is much less important than how you behave.”          

  — Benjamin Graham

Welcome to The Disciplined Investor blog! I have always been intrigued by how the human mind works and what drives our decision-making. Some of the behavioral traits that have helped us survive as a species do not serve us well in the modern world. This concept also applies to our investment choices. We retreat from pain (sell when the market is down) or follow the herd (if everyone else is buying this, I should too). However, these instincts often do not lead to sound financial decisions. The ways that we are wired may at times drive us to make poor investment decisions. Avoiding pain makes a lot of sense when we are too close to fire. But what if we get a similar feeling when the market drops? When our mind screams “get out of here,” how do we understand that pulling out when the market goes down (to avoid pain) may not be in our best interest? These are some of the questions that we will look at in this blog.

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