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The Mole on Lump Sum vs. Dollar Cost Averaging

This article was written by in Investing. 6 comments.

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]

Published or updated January 16, 2008. 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 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 Luke Landes and follow him on Twitter. View all articles by .

{ 3 comments… read them below or add one }

avatar The Money Junkie

Keep in mind also that if you are lump-sum investing a certain amount of money each year that is technically dollar-cost averaging over the long-term

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avatar My Dollar Plan

You also need to take into account if you are paying commissions. (Say on an ETF trade for example.) It may make more sense to lump-sum it to save on expenses.

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avatar Lazy Man and Money

As MDP said, the commissions are important… it’s one reason why I put my Roth IRA in all at once and buy an ETF.

I have to disagree with the Mole in this case. The SPY ETF (mimics the S&P 500) seems to be at the same price it was in March 2000. The QQQQ ETF (mimics the tech-heavy Nasdaq) is still only about 1/3rd of where it was in March 2000.

So if you had portfolio with these in it, you’ll have seen your money do nothing. With some dollar cost averaging, you would likely have seen some gains (as is usually the case when comparing with a market high like March of 2000).

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