Is dollar cost averaging in volatile markets better than investing a lump sum (2024)

Author: Kristin McKenna
Source: Forbes

How should investors navigate wild swings in the stock market? Investing is never easy, especially during one of the most volatile years in the stock market’s history. Whether you have extra cash sitting on the sidelines or are second-guessing your investment strategy, it’s easy to let hindsight bias or a fear of losing money impact your decisions. Especially when investing during a recession or economic crisis, dollar-cost averaging can be an effective way to reduce the risk—and fear—of investing at the wrong time.

Unlike trying to time the market, where you speculate the most opportune time to buy or sell, when you dollar-cost average money into the market, you’re buying at predetermined intervals, without regard to what the market is doing on that particular day.

How dollar-cost averaging works

Dollar-cost averaging helps minimize the impact of volatility when investing as contributions are spread over time instead of invested as a lump sum.

As you can see, the price swings in the stock market can be extreme and sometimes vary significantly from the return over the whole calendar year. But unless you’re investing on January 1st, your annualized performance may be much better—or worse—than the index itself depending on when you invest.

Example of using dollar-cost averaging to invest during volatile markets

Assume you have $50,000 to invest at the beginning of the year. Rather than invest it as a lump sum, you decide to dollar-cost average instead.

You invest $10,000 per month on the 20thday of the month, or on the next day the market is open. For simplicity, let’s just assume you’re only buying shares of an S&P 500 ETF (in practice, you’ll want to consider investing outside of the S&P 500 to diversify). By May 20th, your schedule of buys would look as follows:

When the share price is the highest in January and February, your investment buys you fewer shares. During the March lows, the same $10,000 fixed investment bought you nearly 50% more shares!

If you put $50,000 in the market in January all at once, you’d have 150 shares. A lump sum investment in March would yield 218 shares. But in January, you don’t know the downturn is coming—and in March, you were probably afraid the selloff would continue and may decide to wait it out in cash. You probably wouldn’t have thought the market would rally 37% in 58 days.

By dollar-cost averaging, you’ve helped smooth out the impact of price volatility. Over the course of five months, you were able to buy 173 shares with an average price per share of $295.

An extraordinary example for an extraordinary time

If the price swings in the previous example look significant, it’s because they are. So far, 2020 is shaping up to be one of the volatile years on record for the financial markets, even when comparing 2020 with past recessions and bear markets. Nearly 25% of all trading days resulted in price swings of 3% or more for the S&P 500 and March was the most volatile month in the index’s history with 5% average daily swings.

The fastest bear market in history has (so far) led to an equally stunning recovery. This showcases the benefits dollar-cost averaging can provide, especially in volatile markets. It also highlights some of the limitations.

Hindsight bias is always there

Especially in volatile markets, dollar-cost averaging can help investors avoid big on-paper short-term losses compared to if they had invested all of their money at once on what happened to be the ‘wrong’ day. You won’t benefit from a full investment if you happen to invest at the bottom of the market, but you could also could avoid buying all your shares at the top only to plunge into a bear market.

Since we only know the best time to invest in hindsight, dollar-cost averaging helps reduce the risk of getting an extreme outcome, whether positive or negative.

Dollar-cost averaging makes it easier to stick to the plan

The reality is that many investors don’t like to invest more when the market is down. When everyone is selling and there’s a tremendous amount of uncertainty, it’s difficult behaviorally to go against the trend. In hindsight, after the market has recovered, investors often regret not taking advantage of what they now know to be a great buying opportunity.

Dollar-cost averaging by investing a fixed amount at predetermined intervals can help investors stick to the plan without second-guessing their decisions or getting too emotional as market conditions change. This strategy can help ensure investors aren’t holding cash instead of investing and missing the market recovery.

Dollar-cost averaging vs investing a lump sum

There is no one perfect way to invest cash every time. Dollar-cost averaging can help reduce the impact of short-term price swings, but there’s only so much you can do to plan for a market crash.

One of the downsides to dollar-cost averaging is the opportunity cost of holding onto extra cash. Especially if you plan to invest cash over a longer period, you’ll likely miss out on dividends and income during this period.

The market tends to go up more than it goes down. The pandemic just ended the longest bull market in history. If you had dollar-cost averaged over the last several months of 2019 instead of the beginning of 2020, the $10,000 investment would likely have bought youfewer and fewershares each month. Which brings up another risk: that the market only goesupduring your investment period.

So why discuss the benefits of dollar-cost averaging if research says otherwise? Because too often investors downplay the behavioral aspects of investing until faced with a big decision that carries risk. So when the thought of putting all your money in the market at once seems too stressful—don’t! Dollar-cost averaging can help individuals sleep at night and avoid making fear-driven decisions about whether to invest at all.

Time in the market over timing the market

The stock market is no place to invest for quick returns. While dollar-cost averaging can help reduce the short-term impact of price swings on your performance, consider focusing on the long-term goals you’re investing for instead.

Time in the market is better than timing the market over the long-term, and history shows that the longer you stay invested in the stock market, the better your chances of making money.

Investing in extreme market conditions is difficult, and dollar-cost averaging helps investors stick to their plan when they have capital to put to work. Whether you choose to invest a lump sum or over time, try not to Monday-morning quarterback your decision. Hindsight is always 20/20.

This article was written by Kristin McKenna fromForbesand was legally licensed through theIndustry Divepublisher network. Please direct all licensing questions dollar cost averaging in volatile markets better than investing a lump sum (1)

Is dollar cost averaging in volatile markets better than investing a lump sum (2024)


Is dollar cost averaging in volatile markets better than investing a lump sum? ›

The market rises over time

Is dollar cost averaging better than lump sum investing? ›

Lump-sum investing may generate slightly higher annualized returns than dollar-cost averaging as a general rule. However, dollar-cost averaging reduces initial timing risk, which may appeal to investors seeking to minimize potential short-term losses and 'regret risk'.

Is volatility good for dollar cost averaging? ›

Dollar-cost averaging helps minimize the impact of volatility when investing as contributions are spread over time instead of invested as a lump sum.

What are the 2 drawbacks to dollar cost averaging? ›

Cons of Dollar Cost Averaging
  • You Could Miss Out on Certain Opportunities. Investing in the same stock or fund every month could cause you to miss out on other investment opportunities. ...
  • The Market Rises Over Time. ...
  • It Could Give You a False Sense of Security.
Sep 12, 2023

Is DCA better than buying dips? ›

Deciding between dollar cost averaging vs buying the dip ultimately hinges on your risk tolerance, investment goals, and engagement level with the market. While DCA provides a steady, lower-risk path, buying the dip offers the potential for greater returns, demanding more attention and risk acceptance.

Why is lump sum better than dollar-cost averaging? ›

Some analysis suggests that dollar-cost averaging is approximately equivalent to an asset allocation where only 50 to 65 per cent of the portfolio is invested in risky assets and the rest in riskless assets – such as treasury bills – is still suboptimal compared with a lump sum investment into a portfolio with those ...

Why dollar-cost averaging doesn t work? ›

Cons of Dollar-Cost Averaging

One disadvantage of dollar-cost averaging is that the market tends to go up over time. Thus, investing a lump sum earlier is likely to do better than investing smaller amounts over a long period of time.

Does Warren Buffett use dollar-cost averaging? ›

Among the numerous investment strategies available, dollar-cost averaging is a popular and widely used approach. Its proponents range from Warren Buffett to average investors.

What is better than dollar-cost averaging? ›

When you put all your money in at once, you're more likely to see results quickly. This can be a helpful motivator for a beginning investor. You will often see higher returns with lump sum investing compared to dollar-cost averaging.

What is the best dollar-cost averaging strategy? ›

The strategy couldn't be simpler. Invest the same amount of money in the same stock or mutual fund at regular intervals, say monthly. Ignore the fluctuations in the price of your investment. Whether it's up or down, you're putting the same amount of money into it.

What are the disadvantages of dollar-cost averaging down? ›

Disadvantages of Averaging Down

Averaging down is only effective if the stock eventually rebounds because it has the effect of magnifying gains. However, if the stock continues to decline, losses are also magnified.

What is downside averaging? ›

The main disadvantage of averaging down is increased risk. By averaging down, you're also increasing the size of your investment. So if the share price continues to fall, your losses will become greater than your original position.

How often should you invest with dollar-cost averaging? ›

Consistency trumps timing

It sounds technical, but dollar cost averaging is quite simple: you invest a consistent amount, week after week, month after month (think payroll contributions going into your 401(k) account) regardless of whether the markets are up, down or sideways.

What is better than DCA strategy? ›

Choosing Between DCA and VA Strategies

VA requires investing more money when share prices are lower and restricts investments when prices are high, which means it generally produces significantly higher investment returns over the long term. All risk-reduction strategies have their tradeoffs, and DCA is no exception.

Does DCA reduce volatility? ›

Dollar cost averaging is an investment approach where you incrementally invest set amounts over regular intervals instead of investing a lump sum all at once. This could be daily, weekly, monthly, or any other consistent timeframe. The primary goal is to reduce the impact of market volatility on large investments.

Is dollar-cost averaging riskier than lump sum investing? ›

Investing all at once through lump-sum investing can mean higher returns, so choose this method if your primary concern is performance. But dollar cost averaging can help you gradually increase your exposure to risk over time, which can help you lower stress and avoid regret.

Is dollar-cost averaging riskier than lump sum? ›

A Lump Sum investment into a 60/40 (stock/bond) portfolio has the same level of risk as Dollar Cost Averaging into the S&P 500 over 24 months, yet the Lump Sum investment is more likely to outperform!

Do lump sum investing strategies really outperform dollar-cost averaging strategies? ›

In short, the literature either shows that LS outperforms DCA in uptrend markets or DCA outperforms LS only when the underlying asset prices follow a mean-reverting process or when the markets are trending downward. As far as we know, there is no study showing that DCA outperforms LS during an uptrend market.

Does DCA beat lump sum? ›

Their findings showed that around 67% of the time, someone who invests a lump sum gained higher returns in their first year than someone who followed dollar-cost averaging and drip-fed their investment over the course of the year.

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