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Dollar-Cost Averaging Vs. Lump Sum Investing

This article was written by in Investing. 11 comments.


It’s widely popular in the financial media to encourage the strategy of dollar-cost averaging (DCA) when investing. It’s a simple strategy that calls for investing the same dollar amount at regular intervals. When you assume that stocks or other investments at lower prices are bargains, dollar-cost averaging allows you to buy more of an investment when the price is better (lower), and less of an investment when the price is higher.

For example, consider someone who invests $100 into a broad index fund or ETF every month on the first day of the month. The price of the index, driven by the market, on January 1 is $10, so $100 buys ten shares. The price on February 1 is $12.50, so at this worse price, $100 buys only eight shares. You’ve received a better deal for a larger portion of your shares than you would have if you kept the number of shares you purchased steady rather than the dollar amount. In other words, if your other option was splitting the eighteen shares over two months, buying nine in January and nine in February, your gains would be lower.

This is, of course, a simplification of the issue. Many people often argue that, under the assumption that the stock market generally rises over long periods of time, you’d almost always be better off by buying the full eighteen shares as early as possible — in this case, January 1. Assuming the values trend upwards, that’s always the case — or at least it averages out to be over time. Many financial gurus then suggest forgetting about the idea of dollar-cost averaging and turn towards investing a lump-sum as soon as possible.

Reality gets in the way of that idea, unfortunately. Over my lifetime, I might invest $1 million. I have no idea of that will be true of course, because I cannot predict my future, but it’s a good figure to start with. Of course I’d be better off investing that $1 million at the moment I am legally allowed to do so, while just letting the account grow (on average) over large swaths of time. In fact, isn’t this the dream of every time-traveler? “If I could just take the $100 I have now, put it in the bank in 1795, and show up to collect the proceeds this year, I’d be a multi-millionaire!” Those who prefer gambling might be interested in taking Grays Sports Almanac: Complete Sports Statistics 1950-2000, a surprisingly thin compendium, back to 1955 and placing bets. (Come to think of it, Biff Tannen from the alternative 1985 reminds me a little of Donald Trump. Is it just me?)

Comparing lump-sum investing with dollar-cost averaging is not feasible most of the time. Thanks to reality, most of us are not time-travelers. We cannot take the amount we intend to invest over our life time and do it all at once at the beginning. You can, however, use leverage to invest more than you can afford to take advantage of these gains, but your returns will be hurt by the interest you pay on this debt and it amplifies your risk to often unacceptable levels. No, most people don’t invest using a lump sum because they need to earn the money they plan to invest through income, and that generally happens over time.

Furthermore, the more frequently buy an investment, the possibility for racking up transaction fees is higher, and these eat into your profits quickly. That’s a negative aspect of DCA, and it’s avoidable by dealing only with low-cost investments.

Dollar-cost averaging is effective because it allows people who can only budget for a small amount of investing to buy more shares of their investment when prices are lower. Most people can’t afford to invest in a lump sum.

Published or updated May 6, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 11 comments… read them below or add one }

avatar No Debt MBA

This leaves out the implications of tax-advantaged accounts. The tax advantage of a Roth IRA in particular would strengthen the “the stock market generally rises over long periods of time, you’d almost always be better off by buying the full eighteen shares as early as possible” since you want any gains to be captured tax-free. It’s also very feasible to contribute to your IRA upfront and in a lump sum since it’s only $5,000.

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avatar UH2L

I believe in educated dollar cost averaging. Don’t just buy at regular intervals, buy when you think the market is in a relative dip, like after the market tanks for a few days in a row. You can take advantage of market variation even if the market tends to go up in the long term. Sell in a similar manner. If you make 2% 10 times, you earn 21.9%!

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avatar rewards ♦31 (Newbie)

If over the long term the market increases, buying at these dips will likely be worse than buying in a lump sum. For example, if the market increases from $100/share to $200/share over 10 years (annualized 7%) then one would do better to buy all in during Year 1 than to buy at the periodic dips which will usually be >$100/share.

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avatar UH2L

Good point. I guess, the relative dips I am talking about are ones within a few weeks of the date you would have bought it all in one lump. From random variation, the stock or fund could easily go up or down a couple of percent a few times in the course of two weeks. When I do the educated dollar cost averaging, I’m doing it between funds so I guess I should call it micro-rebalancing. From random variation, as they all go up over the long term one type of fund may be substantially higher relative to another type of fund. You can make money with small back and forth sales/purchases.

Also, even though stocks tend to go up over the long term, opportunities arise in crises to buy stocks/mutual funds more cheaply as in the financial crisis of 2008. If one had put $10,000 in stocks in August of 2008 in a lump sum, that person would not have done nearly as well as somebody who invested $100 in August, and then used the huge drop to invest the other $900 within the next couple of months. Of course, there is market guesswork involved but buying blindly in a lump sum can work against you. I certainly wouldn’t do it now. I think stocks are inflated based on the reality of the jobless and the fact that interest rates have to go up at some point in the near future.

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avatar Ceecee ♦53 (Newbie)

I prefer to put the stock on my watchlist and buy on the dips—–doesn’t always work out but often enough it does. I guess the key to this is knowing if the dip is temporary.

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avatar Rob Bennett

I believe that all of the confusion re lump sum vs. DCA is the result of a failure to consider the effect of valuations.

If stocks are selling at good prices, you want to get in as soon as you can. If stocks are selling at poor prices, you don’t want to get in at all. DCA doesn’t keep you out but at least it protects a portion of your money for a time (it may end up being long enough or it may not).

DCA makes people feel good because they are purchasing at different prices and thereby feel protected from overpaying. The problem is that stocks can remain at insanely high prices for a long time. So you might DCA over a 10-year time-period and be buying into poor long-term value propositions the entire time.

Rob

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avatar Jacob @ My Personal Finance Journey

I’ve heard that if someone has the money (ie a large lump sum), they should just go ahead and invest it all at once. At least, that’s what Jeremy Siegel concluded in his book, Stocks for the Long Run. However, I think that dollar cost averaging is good because often people get paid on a monthly basis, and it makes sense for them to invest it then before being spent.

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avatar colin moynihan

hi, i am a huge fan of your site, and i am similarly nerdy about my personal finances. i have kept my net worth since 2006 and read/study personal finance, investing, and life planning regularly. with luck, i will follow similar footsteps to yours and leave the rat-rate of my corporate financial analyst job to pursue a solo career focused on financial/life coaching, but i question this type of article. are you trying to educate readers about what dollar cost averaging is? it’s funny to compare to lump sum investing because clearly no one (or at least 95% of readers) will never face this dilemma. i would suggest you discuss the alternative, which would be market-timing, and maybe analyze the differences. i’ll probably follow a dollar cost averaging approach, like most people, because that is how my savings stream will flow through my career, but i am always wondering if i could do better by holding money until the market dips and trying to time it. you have a following of readers who probably wonder the same thing.

anyways, i have a blog/personal finance website idea in the works and with luck we will be communicating as peers in the personal finance community someday soon. as a 28 year old with a wife and 5 month old son, i think im doing pretty well with a net worth (excluding fixed assets like furniture etc. of around 125K), but you are certainly motivation. keep up the good work. and congratulations on your success.

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avatar rewards ♦31 (Newbie)

From your article it sounds like you give this example:

Dollar Cost Averaging – buy Jan 1, Feb 1, Mar 1, … , Dec 1
Lump Sum Investing – buy Jan 1 2011, Jan 1 2012, Jan 1 2013, …

If so, then in reality both are forms of dollar cost averaging.

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avatar lynn ♦155 (Cent)

I don’t pretend to know much about the stock market. So as an outsider looking in, lump sums on dips looks more appealing. There are so mant other vehicles to make money on, I have always prefered those.

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avatar skylog ♦368 (Nickel)

“Dollar-cost averaging is effective because it allows people who can only budget for a small amount of investing to buy more shares of their investment when prices are lower. Most people can’t afford to invest in a lump sum.”

this is a key point. people can theorize on either side, but for the small time investor, or an investor just starting out this is important. not only from the numbers side, but perhaps just to set up a plan to stick with.

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