Recently, I asked whether I should fund my Roth IRA in one lump sum or dollar cost average throughout the year. It’s unlikely that I’ll qualify to fund a Roth IRA this year, so now this question is moot. Regardless, Money Magazine’s “The Mole,” an anonymous financial adviser insider, tackled this question (though with an investment of $600,000 rather than $5,000).
Funding each year’s Roth IRA completely once a year is actually just a slower for of lump sum investing; if you had $150,000 ready to invest when you first started your career — an estimate I based on 30 years of a $5,000 full investment though as we know the maximum contribution changes — then investing the entire sum at the beginning would have returned much more than $5,000 each year.
The Mole’s point is that your asset allocation in your investment should match the risk level you’re willing to take, and over the long term, lump sum investing presents higher returns.
Most of us, however, don’t view our lives mathematically. For example, if you had put this $600,000 in the market in March of 2000, it would have taken nearly a 50 percent hit two and a half years later. And if you were like most investors, the pain of this loss would have compelled you to sell long before the recovery began. Had you not sold, you would likely have seen your global set of index funds delivering some pretty decent returns over the total period.
Psychology tends to get in the way of sound financial decisions.
Of course, if you don’t have the lump sum available, then you have no choice but to dollar cost average.
Investing $600K: Lump sum vs. little by little [Money Magazine]