2023 Q1 Quarterly Market Review – Dollar Cost Averaging vs Lump Sum Investing (2024)

By Schultz Collins Investment Counsel on April 28, 2023

Market volatility, economic uncertainty and inflation continued in the first quarter. We also saw several high-profile bank failures toward the end of the quarter. However, despite the persisting themes, the first quarter of 2023 saw markets continue to rebound as the Fed and other banks stepped in to prevent contagion in the banking sector.

Figure 1

Data provided by Morningstar as of 4/4/2023. For illustrative purposes only.

The aggregate global stock market, as measured by the MSCI All Country World Index of global stocks rose 7.44% in the first quarter and ended the trailing 12-month period down 6.97%.

In the US markets, the S&P 500 Index of large company stocks increased by 7.5% for the quarter and is down 7.73% over the past 12 months. Small companies in the United States as measured by the Russell 2000 Index, fared worse during the quarter, up only 2.74% in comparison, and down 11.61% over the trailing 12-month period. The Dow Jones US Select Real Estate Investment Trust Index, a benchmark for US real estate performance, was up 2.77% for the quarter and down 20.99% over the previous 12 months.

International company stocks continued to see a similar recovery in the first quarter with large international company stocks outperforming large US stocks. Overseas stocks, as measured by the MSCI Europe, Australasia and Far East Index, rose 8.62% for the quarter, and fell 0.86% over the past 12 months. The MSCI Emerging Markets Stock Index was up 4.02% over the past 3 months and declined 10.31% over the trailing 12 months.

Bond holders continued to see relief in the first quarter. The combined market for government and corporate bonds in the United States, as measured by the US Aggregate Bond Index, was up 2.96% for the quarter and down 4.79% for the trailing 12-month period. The global bond market, as measured by the World Government Bond Index, again rose more than the aggregate US bond market in the first quarter, up 3.51%, yet experienced a larger drop over the trailing 12 months, down 9.56%. Intermediate-term corporate bonds in the US, as measured by the US Corporate Bond Index Intermediate, rose 2.5% in the first quarter, and fell 1.99% over the last 12 months.

Figure 2

Data provided by Morningstar as of 4/4/2023. For illustrative purposes only.

Interest rates continued to decline some in the first quarter. The yield on the 10-year Treasury was at 3.48% on March 31^st, down .4% from the end of 2022. Amidst the banking turmoil, The Federal Reserve continued its efforts to conquer inflation with a rate hike in late March of 25 basis points. The Federal Reserve is forecasted to raise interest rates, although at a slower pace, through the end of 2023 as they expect slower economic growth and persistent inflation.

Figure 3

Data provided by Federal Reserve Board as of 4/4/2023. For illustrative purposes only.

In the remainder of this quarterly market review, we’d like to explain two different investment strategies: dollar cost averaging and lump sum investing. We’ll start off by explaining the difference between the two, then go through some examples, and finally conclude with the results of some analysis.

To explain dollar cost averaging and lump sum investing, imagine that you received a large sum of money, i.e., from an inheritance or a legal settlement, and want to invest it. If you invested the money all at once, you would have made a lump sum investment. On the other hand, if you divide that money equally and invested each division at regular intervals through time, you would have dollar cost averaged your investment.

Let’s go through an example of lump sum investing. Imagine you had $100,000 in cash on August 1^st, 2018, and you invested it all at once in the S&P 500. Twelve months later, on July 31^st, 2019, the value of your invested would be $107,986, and the return on investment would be 7.99%. This scenario is presented in Figure 4.

Figure 4

Data provided by Morningstar as of 4/4/2023. Past performance is no guarantee of future results. Hypothetical returns do not account for fees and transaction costs. For illustrative purposes only.

Now instead of investing it all at once, suppose you want to dollar cost average that $100,000 over twelve months. On August 1^st, 2018, you would invest $8,333, which is $100,000 divided by twelve months. That initial $8,333 would grow by the time you made your second $8,333 investment a month later. Then on October 1^st, 2018, your two investments would have grown, and you would make your third $8,333 investment. This would happen twelve times by July 31^st, 2019. The value of your investment would be $107,874, and the return on investment would be 7.87%. Figure 5 illustrates this scenario.

Figure 5

Data provided by Morningstar as of 4/4/2023. Past performance is no guarantee of future results. Hypothetical returns do not account for fees and transaction costs. For illustrative purposes only.

So, which of our examples did better? Figure 6 compares the two examples, and it shows that the lump sum investment strategy outperformed the dollar cost averaging strategy by 0.11%. But this is just one example.

Figure 6

Data provided by Morningstar as of 4/4/2023. Past performance is no guarantee of future results. Hypothetical returns do not account for fees and transaction costs. For illustrative purposes only.

Let’s look at another example. Which strategy would fare better if you had to make the investment decision just one month later, on September 1^st, 2018. Figure 7 compares the two strategies for the 12-month period of September 1^st, 2018, to August 31^st, 2019. In this example, dollar cost averaging did better than a lump sum investment. But again, this is just one example.

Figure 7

Data provided by Morningstar as of 4/4/2023. Past performance is no guarantee of future results. Hypothetical returns do not account for fees and transaction costs. For illustrative purposes only.

If we continue producing examples in this manner, we can combine them into a large dataset to analyze. This methodology is called a rolling period analysis. In our analysis, we picked a 12-month window of time for our comparison and moved the window by one-month for each new comparison. We started in January 1991 and ending in December 2022, for a total of 373 comparisons. The results of our analysis are shown in Figure 8. The data suggest that dollar cost averaging underperforms lump sum investing by 5.52% on average. Furthermore, dollar cost averaging underperforms roughly 80% of the time.

But that doesn’t mean lump sum investing is better. It’s important to notice that dollar cost averaging is less risky. This is observed in the lower standard deviation value of 9.63%, compared to 16.52%. A lower standard deviation means returns varied less from the average. Furthermore, the minimum return of the dollar cost averaging strategy is -34.03% versus the -43.32% minimum return of the lump sum investing strategy. If you are concerned about losing your money, then a dollar cost averaging strategy could be better.

Figure 8

Data provided by Morningstar as of 4/4/2023. Past performance is no guarantee of future results. Hypothetical returns do not account for fees and transaction costs. For illustrative purposes only.

Now that you have a better understanding of the two strategies, you may a few questions. For instance, what role does transaction cost play, or the interest on cash & equivalents? Dollar cost averaging requires more trading, so may cost more. On the other hand, the dollar cost averaging strategy may benefit from interest earned while the dollars are waiting to be invested. In our analysis, we assumed transaction costs and interest payments are relatively small.

Furthermore, you may wonder how the results look when examining longer windows of time, different underlying investments, or alternative analytical methods. It’s impossible to be exhaustive, but we also analyzed two and three-year windows of time, a 60% stock and 40% bond investment, utilized two other methodologies. The results are presented in the appendices.

All our analyses suggest that dollar cost averaging underperforms lump sum investing, on average. However, dollar cost averaging is less risky. So which strategy is better, depends on your risk preferences and goals. If you have any questions about your risk preferences and goals, or about our analysis, please reach out to us.

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