Is Dollar Cost Averaging or Lump Sum Investing better?

DCA is investing all the available money over periods of time (i.e., one payment a month over several months). Lump Sum is investing all the available money at once.

So, which one to use?

Therein lies why it’s important to truly understand your own risk tolerance. Lump Sum historically provides better returns in stocks, bonds and the traditional 60/40 mix, according to research from the CFA Institute. The sooner one enters the market typically the better the results, but not always since market swings can negatively impact Lump Sum. If money enters the market all at once on Monday and on Tuesday the market drops dramatically, it can seem that you made the wrong decision.

“As the old saying goes, ‘Time in the market is more important than timing the market,’” said Matt Finn, Senior Managing Director of Portfolio Construction and Manager Research, and Chief Economist for 1834, a division of Old National Bank. “For investors with a long-time horizon, in 20 years it probably won’t matter if you invested on a Monday or a Tuesday.”

What we typically advise

As always, adjust based on market conditions. However, DCA is typically a good way to minimize regret since timing the markets correctly is impossible. The one caveat is if the money was already invested, it typically makes sense to use Lump Sum since it was already at work somewhere else.

Within DCA, we usually advise two paths:

• Three installments overall. Invest one third of the allocation to equities, and all the bond allocation immediately. Then invest one half of the remaining balances into equities the next month and the remaining balance the following month.
• Or invest the money earmarked for equities monthly for up to one year. Unless the client is particularly sensitive to relative fixed income performance, we would still advocate investing all the bond allocation up front to immediately begin earning income while the equity allocation is still in a money market account. Additionally, new issue bonds can take several weeks to months to purchase. It is better to have the fixed income desk working the entire bond allocation up front rather than waiting.

Those that experienced a liquidity event (such as a business sale or inheritance) could understandably be reserved, which is another reason DCA makes sense. Although Lump Sum mathematically performs better on average, DCA is typically the preferred approach for money that wasn’t previously invested. Remember, these are general guidelines. The situation and dollar amount play a role. Market conditions are also a huge factor and strategies can be tailored.