Why lump-sum investing beats dollar-cost averaging (2024)

If you have the good fortune to be starting the new year with a lump sum of cash you’re looking to invest, you’re likely worried about getting into the market at the wrong time.

There are three main options as to how you invest that money: dollar-cost averaging, in which you systematically invest equal parts into a risk-appropriate portfolio over a set period; investing the lump sum in a risk-appropriate portfolio immediately; or sitting on your cash until what feels like a good time to invest.

Dollar-cost averaging may seem like a smart strategy. The logic is that when stock prices are high, you are buying fewer shares, and when prices are low, you are buying more shares. Despite its simple appeal, dollar-cost averaging has been proven suboptimal many times.

In a 2020 analysis, I compared lump-sum investing with dollar-cost averaging over a 12-month period in six stock markets and evaluated the performance over the following decade. While the cash was being deployed, it earned the rate of one-month U.S. Treasury Bills – a stable asset with low expected returns, similar to cash.

I found that investing a lump sum beat dollar-cost averaging about 65 per cent of the time across the markets in my sample. The approximate average annualized cost of dollar-cost averaging was about 0.38 percentage points over 10 years

I also looked at the performance of dollar-cost averaging in the worst 10 per cent of outcomes for lump-sum investments. I wanted to know whether dollar-cost averaging would have helped in the cases where a lump sum did not work out well.

In this subsample dollar-cost averaging has a small advantage on average, but trails lump sums in slightly more than 50 per cent of the periods. Keep in mind that this in the worst periods for lump sums. In other words, even if you knew for certain that it was a bad time to invest a lump sum – which, of course, you don’t – dollar-cost averaging is not a sure bet to improve the outcome.

In addition, I ran the analysis for the U.S. market when U.S. stock valuations were in the 95th percentile of expensiveness and found that lump sums continue to dominate.

My findings that dollar-cost averaging does not stand up to its reputation as a smart approach to deploying cash are not revolutionary. A long list of academic papers going back to the 1970s have suggested that dollar-cost averaging delivers suboptimal results.

The strongest argument in favour of dollar-cost averaging is behavioural. In short, dollar-cost averaging can help with minimizing regret by avoiding investing a lump sum right before a crash. Instead, dollar-cost averaging feels like making a series of smaller investments, spreading out the regret opportunities.

While this psychological effect is a reasonable argument for dollar-cost averaging, if an investor feels the need to dollar-cost average into a portfolio, I have to wonder whether the portfolio is too risky for the investor. It is absolutely true that investing a lump sum right before a crash can be uncomfortable, but remember that even in the worst lump-sum investment outcomes dollar-cost averaging would not necessarily have been a better option.

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 allocations.

The alternative approach of waiting and hoping for a better time to invest, otherwise known as trying to time the market, is not much help, either. In another analysis, we looked at waiting for 10 or 20 per cent market declines to invest a lump sum and found that this strategy underperforms on average and in most of the 10-year periods in our sample.

Financial markets are constantly pricing an uncertain future. There will always be some reason – things like current market valuations being too high, geopolitical events being too volatile or economic news being too dreary – that makes the current moment feel like a terrible time to invest. But sitting on cash comes with its own risks for a long-term investor.

If you have a lump sum available to invest for the long-term, it is likely optimal to invest it as soon as possible in a portfolio that is appropriate to your risk tolerance. There is a behavioural argument for dollar-cost averaging, but if you are so worried about regretting the decision to invest a lump sum that you deem dollar-cost averaging necessary, it might be a sign to reconsider your asset allocation.

Benjamin Felix is a portfolio manager and head of research at PWL Capital. He co-hosts the Rational Reminder podcast and has a YouTube channel. He is a CFP® professional and a CFA® charterholder.

Why lump-sum investing beats dollar-cost averaging (2024)


Why lump-sum investing beats dollar-cost averaging? ›

Dollar-cost averaging may spread the risk of investing. Lump-sum investing gives your investments exposure to the markets sooner. Your emotions can play a role in the strategy you select.

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 i don t recommend dollar-cost averaging? ›

The Market Rises Over Time

If you don't increase your monthly investment over time, you may end up with fewer and fewer shares on average. If you can afford to make a lump-sum investment instead of dollar cost averaging, you could come out ahead if your timing is right.

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.

What are the benefits of lump sum investing? ›

Investing a lump sum means that you don't have to try to figure out the best time to make periodic investments. You can set up your portfolio and let it grow. A 2021 Northwestern Mutual Life study showed that investing a lump sum generally outperforms dollar-cost averaging over various periods of time.

What are the 2 drawbacks to dollar-cost averaging? ›

Pros and cons of dollar-cost averaging
  • Dollar-cost averaging can help you manage risk.
  • This strategy involves making regular investments with the same or similar amount of money each time.
  • It does not prevent losses, and it may lead to forgoing some return potential.

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.

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.

How often should you buy stocks for 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.

Why would an investor choose dollar-cost averaging over market timing? ›

Dollar-cost averaging makes a volatile market work to your benefit. By adding money regularly, you're going to buy at times when the market is lower, therefore lowering your average purchase price and actually acquiring more shares.

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 are the 3 benefits of dollar-cost averaging? ›

Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing habit, be more efficient in how you invest and potentially lower your stress level—as well as your costs.

Should I still be dollar-cost averaging? ›

DCA is a good strategy for investors with lower risk tolerance. If you have a lump sum of money to invest and you put it into the market all at once, then you run the risk of buying at a peak, which can be unsettling if prices fall. The potential for this price drop is called a timing risk.

What are the disadvantages of lump sum investing? ›

A lump-sum investment is made at a point in time. The price you pay for the investment(s) may be high or low. If you invest when prices are high, you run the risk of incurring a loss if you need to sell in the near term.

Why do people choose lump sum? ›

The lump sum provides a significant amount of immediate cash. Many opt for this option to avoid long-term tax implications. Annuity payments offer tax benefits and can prevent overspending lottery winnings. They provide guaranteed income, and can lead to more money in the long run.

What is the best investment for $100,000? ›

6 approaches and strategies to invest $100,000
  • Park your cash in an interest-bearing savings account.
  • Max out contributions to retirement accounts.
  • Invest in ETFs.
  • Buy bonds.
  • Consider alternative investments.
  • Invest in real estate.
Apr 3, 2024

What is the difference between lump sum and dollar-cost averaging of dollars and data? ›

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.

Why is lump sum so much less than annuity? ›

A lump-sum payment provides a smaller immediate payout, while an annuity spreads payments over several years for a larger overall amount.

What is the smartest thing to do with a lump sum of money? ›

Build emergency savings

However you choose to invest your lump sum, it may also be a good idea to build an emergency savings pot. Typically, an emergency savings pot should cover about three months' salary and be quickly accessible so that you can use it whenever you need it.

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