Dollar-cost averaging versus lump-sum investing
There may come a time when you have some money to invest, a decent sum of money.
So, what is better?
Dollar-cost averaging (DCA) versus lump-sum investing (LSI)?
This post has your answer.
Dollar-cost averaging versus lump-sum investing
Investing is never easy. I believe that is true mainly because you tend to fight a consistent enemy in the mirror – your investing behaviour. Wild stock market swings can have a devastating effect on an investors’ portfolio if they behave inappropriately. There have been some very wild swings in the stock market – both down and up – over the last 20 years, a couple of major crashes to navigate in fact.
Source: Macrotrends – S&P 500 Historical Annual Returns
When will the next market calamity hit?
I have no idea of course and nobody else does either. However it’s important to remember based on historical lessons at least what goes down, drastically even, usually comes back up again. In fact, what goes down infrequently usually comes back up more frequently – which is precisely the point to this DCA versus LSI decision!
When you have that extra cash sitting on the sidelines it’s very easy to let hindsight bias or a fear of losing money at all impact your decisions. I know, I’ve been there too. This makes dollar-cost averaging an effective way to reduce the risk (rather your fear) of investing at the wrong time. But that’s not the best decision.
How dollar-cost averaging works
Dollar-cost averaging helps investors by spreading out investing decisions over time, ideally at pre-determined intervals. Let’s walk through an example.
Let’s assume you have $12,000 to invest at the beginning of the year, contributions to your Tax Free Savings Account (TFSA) for you and your spouse.
Rather than invest it as a lump sum, $6,000 to each account, you decide to dollar-cost average instead. You know getting your money to work in the market is important, but you feel better to spread it out, so you decide to invest $1,000 to each account on the 1st day of the month for six months until all TFSA contributions are made. Through dollar-cost averaging, you can sleep better at night knowing you will be investing at different times over the coming months to smooth out stock market volatility.
But it’s usually the wrong decision.
I’ve leveraged this calculator for illustration purposes, using U.S. stock market data.
While DCA decisions can make great sense for investors who are usually spooked by a market downturn, and all the investing anxiety that comes with that decision, the reality is it’s usually better to invest all the money at once, at least two-thirds of the time.
So, if you ever find yourself receiving a cheque for a large sum of money; you have a year-end bonus from work; you have an inheritance, investing the money at once is usually the better decision.
Why lump-sum investing (LSI) works
There is a great deal of evidence to suggest that investing money right away, beyond a blogger’s calculator above, is usually best. Here is one of my favourites:
In 2020, Nick Maggiulli, Ritholtz Wealth Management’s chief operating officer, compared the performance of investing in the S&P 500 Index using a lump sum versus 24 consecutive monthly DCA contributions. Going back to 1997, he discovered that lump-sum investing produced higher returns 78% of the time with an average market outperformance of 5%. He found similar results using other markets and asset classes.
“The longer you wait, the worse off you will be, on average. The data I will present later in this post will illustrate this clearly. It’s like the saying goes:
The best time to start was yesterday. The next best time is today.
If you grasp this concept, then the rest of this post will flow much more easily.”
You can read the entire report/post here.
This only makes sense and you can see that reflected in the S&P 500 chart above. Historically, equity markets tend to go up. This means I believe, using historical data, that LSI will tend to work out better for investors that have a long-term investment timeline on their side. This means they can take advantage of any time needed to recover from a market loss if or when that happens.
Dollar-cost averaging versus lump-sum investing summary table
Ultimately, only you can decide your sleep at night factor. Personal finance is always personal.
An investor with an already substantial amount of money invested will have less reason to be anxious about dropping $6,000 (or $12,000 between partners) at once via LSI than a younger investor just starting out on their TFSA journey.
Of course, LSI vs. DCA is this context is not about a long-term, multi-year, bi-weekly or monthly approach to investing. That’s great of course. If/when you buy periodically into the market in this approach, yes, you are making small, periodic investments but you are not keeping cash lying around. You simply don’t have it.
Time in the market over timing the market
There is no one perfect way to invest cash every time. Dollar-cost averaging in this context 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.
Personally, I’ve learned to embrace market crashes and benefit from them.
But you simply can’t ignore the behavioural benefits of investing. So, if your gut is telling you DCA is better than LSI, it’s OK to listen near-term. Dollar-cost averaging can help investors avoid making fear-driven decisions about avoiding investing at all – which is an even bigger mistake long-term.
So, the ol’ adage is true: time in the market is better than timing the market.
Whether you choose DCA over LSI is your choice of course but the punchline remains the same: sticking to a well thought-out investing plan and consistently adding money to your portfolio should work well very over time, no matter which investing approach you choose.
How can you prepare for a market meltdown?
Check out from Vanguard why DCA just means taking on investment risk – later. From the article:
“We conclude that if an investor expects such trends to continue, is satisfied with his or her target asset allocation, and is comfortable with the risk/return characteristics of each strategy, the prudent action is investing the lump sum immediately to gain exposure to the markets as soon as possible. But if the investor is primarily concerned with minimizing downside risk and potential feelings of regret (resulting from
lump-sum investing immediately before a market downturn), then DCA may be of use.”
How much cash should you keep?
Investors: what approach works for you? Do you prefer DCA versus LSI? Do share in a comment below.
Thank you for the information that you provide here! I am considering transferring mutual funds from RBC to a Robo advisor managed portfolio. This transfer would happen all at once…not sure if this is considered LSI or not. Given the current market, I’m wondering if this is the best move right now. Any info would be greatly appreciated.
Well, typically LSI vs. DCA is new money (money not yet invested at all vs. transfer) but at the end of the day, if you are worried a bit with any market changes, DCA is just fine and works very well for many.
Best wishes and thanks for the kind words!
Great and timely post. My view is that the best time to invest is whenever you have it. Got a big bonus at work? LSI-it. Going pay cheque to pay cheque, DCA-it. I haven’t always followed my advice though – I usually prefer to build a cash cushion and LSI it when it hits certain thresholds or the beginning of the year (top up TFSAs, plan for RRSPs, kids RESPs, etc.).
Don’t fear LSIs – if you are early in your investing career, unless you received a life-changing inheritance, than what looks like a mountain today will likely be a molehill in 20 years, or at least any variance from market timing will be a molehill. If you are late in your career, then relative to your accumulated investments, any large lump sum likely isn’t a majority of your holdings – don’t over think it.
Keep in mind “time in the market” – sitting out wondering what market timing day will be best increases the chance you will miss the dividend payment date – once those horses have left the barn, they’re gone for good and you didn’t get to ride.
Great point Bart = don’t overthink it. I try not too myself but even as an experienced DIY investor I sometimes struggle too even though I know what the right answer (LSI) usually is!!
Thanks for your insightful comment.
Best wishes for 2022!
I must admit that I have the problem of staying invested and investing a lump-sum and so far it worked fine since my only focus now is on dividends and dividends growth so I like to see my money working for me today rather then a year from now if I apply the DCA and if the markets goes deep in red I’ll buy more.
Mark what’s your opinion on AQN dividend safety I read an article about and read some comments but as for yahoo finance the payout ratio is 64% way below Fortis for instance .
Also what’s on your list for Canadian stocks for 2022.
Thanks for the post
Ya, I mean, I think dividends really help me stay invested Gus – I see the income flowing in and that helps my behaviour and bank account. AQN is making me a bit nervous but they also have committed to fulfilling many projects to be online in 3 more years – so, when I see lots of capital being invested that’s a good thing for longer-term growth.
I’m not changing my path with this one right now. DRIPping many units every quarter and will continue to do so.
I should be posting my list for CDN stocks soon. I like EQB, WCN and ATD for my stocks in 2022. Maybe a bit more NA bank too! 🙂
Dollar cost averaging is somethinmg you do with DRIPs, but certainly not when you want to take a position in a stock.
There is no good reason I can see, why you would do it this way unless you were becoming an extra $1000 every month that you have to invest.
Hey Mark, good post. I would have thought differently. Meaning being patient for the next downturn of 20%, 30% etc. Good to know the stats and reality on this. I’ll forward to my kids…good timing. Take care.
You know, there might be a good downturn coming Paul. I wish I knew. 🙂 All this said, DCA in this post is not about long-term DCA over many years of investing. Rather, if you were to invest $6K now or spread out that $6K over the coming 6 months, likely LSI will produce better returns (historically).
That said, DCA can work for any “window” of time but we don’t know what is best only in hindsight.
I will be personally keeping some cash ready for 2022 – when the market dips. If I was a betting man, the early part of 2022 could be rocky only for things to open up later this year.
Another great post, Mark!
I often find myself having this conversation with clients who have received an inheritance or proceeds of selling a home. It’s the psychological part that has to be discussed. E.g., “How would you feel if you invested everything and the markets tanked tomorrow?” So while the numbers support LSI, DCA can (for some) let someone sleep better, which can’t be dismissed. If someone is hesitant to LSI, then setting a specific amount on specific dates is what we usually agree on.
Emotions, behaviours, psychology, etc. are such huge parts of financial planning that I find myself often using the phrase, “Personal finance is more personal than finance”
WAY more emotions over math when it comes to money = which is fine = we are human afterall. 🙂
Any historical numbers can look good on paper of course but the practicality of it all must be always considered. I call it the sleep-at-night factor.
Have a great 2022 and I’m sure I’ll hit you up with a few blogpost ideas to chime in on. I have a few now!
Thanks Mark, the LSI over DCA advice makes sense, and appears to be backed by some solid, longitudinal data. However, for those of us who often struggle with over-analysis and inertia, especially now as equities have enjoyed a strong run and are at all-time highs in some markets – are we due for a significant correction? It seems surreal to watch market increases while the whole world struggles with Omicron.
What wisdom do you have for those with a lump sum to invest in January of 2022? Especially for those closer to retirement?
Don’t kid yourself Ron, I still struggle with lump-sum investing but I tend to do it more often than not.
Personally, if I use the $6K in my article as a real-life example, I’ve already moved it into my TFSA. It’s done for me and over even though the market just dropped recently a bit. There is nothing I can do now.
For those closer to retirement, or any phase, if DCA makes them feel better by limping-in per se I say for it. A sleep-at-night factor is very hard to ignore.
In decumulation phase so the only lump sum I get to do is my TFSA in Jan of each year.
Just advised the bank on how much I wanted out of my RIF (1/2 minimum withdrawal) today.
Money will go to the TFSA, $6K, build a little more of a cash wedge for the upcoming income tax season and the rest in to a non-registed investment account,
So I get both worlds, lump sum TFSA in Jan and then the rest of the year is DCA as I usually keep pretty close to 100% available cash within the registered accounts deployed in to stocks. Pretty well buying something every month in the TFSA as funds are sufficient for that. The LIF and RIF get to accumulate some cash in the last six months so as to complete the minimum withdrawal requiremnts for the year as well as have some dinaro for the January contribution.
So this is the first year i am taking a 1/2 minimum withdrawal on the RIF with no payable taxes. Towards the end of the year, Nov/Dec, i will take out the remaining 1/2 withdrawal and pay what I figure would be my 2022 tax due. Also withdraw the full minimum on the LIF at that time.
This allows me to re-invest within the RIF and LIF without income tax implication until the Nov/Dec time frame.
The “extra” withdrawal monies at that time go in to the non-registered account. This way I get non taxable dividends within the RIF/LIF for a good part of the year and will only have taxable dividends, if any depending on payment date, in the non-registered account for the last month.
Will see what next year brings from the tax man as the non-registered account builds in 2023 mainly.
Just trying to minimize taxes or OAS clawback. Probably a losing cause but that is a good position to be in.
Will be interesting to see how close I get to the OAS clawback line this year (2021)
The more room I have then the more I can take out. LIF is limited to 8% maximum but the RIF is wide open.
Will try to run as close to max income as possible without tripping the clawback. Bit more difficult as the non-registered account builds and the minimum withdrawal rate increase each year.
You continue to seem to have a well-oiled process for your money Ricardo – kudos!!
I think trying to minimize taxes or OAS clawback is very smart of course. There are many retirees that I’ve talked to that are purposely moving increments of RRSP money out now, in their 50s and 60s, to avoid OAS headaches later on. They want that gov’t benefit.
I think if you can nudge close to OAS clawback territory but avoid it, that’s probably a very good income and tax-level to aspire to. We see that a lot at Cashflows and Portfolios and it seems to be a “sweet spot” for many comfortable retirees.
I believe that the OAS “clawbacK’ is actually taxed (federal) back so all is not lost as it increases your tax paid for the year. It is not as if they just took the money away from the payment. I may be wrong on that though..
Yes, when OAS clawbacks start, if they start for some retirees, all is not lost until a high income threshold. 🙂
Once again great article on LSI and DCA. To me LSI if you have the resources hence putting 6K on my TFSA first week of January then RRSP if there is still room. We then do DCA to non-registered accounts for next year contributions!
I am a huge fan of what you’re doing!
I’m all for LSI over DCA assuming any saver or investor can live with their decision. If you can’t sleep at night because you’re thinking about the what-ifs, then simply do what is best for you financially and emotionally. No one-size fits all in my book. There are lots of ways to save and invest and it can be successful on a personal note vs. what others do!
Very kind Rommel and I appreciate your readership and social media shoutouts! 🙂
Best to you in 2022.
When I received my first tranche of inheritance / insurance money I “LSI’d” it right away. The date was mid February 2020. OUCH! A month later my wife and I were in the Dominican Republic watching COVID panic really start and it was very painful to watch that money dwindle away.
LOL – but it didn’t deter me, with each successive tranche I deployed it right away. I also started borrowing from our HELOC to invest. The money from the HELOC was more of a dollar cost averaging approach, but mostly because of the added risk – I wanted a bit more confidence that the market was going to continue it’s post May-2020 trajectory upwards, which of course it did. In hindsight I wish I had the *$^# to have invested it all in one shot, but I think it’s a good example of how both approaches can make sense.
Good on you James. I too, wish I had the XYZ to fire a ton of money into the market in May 2020 or even April 2020, but you never really know right?? Both approaches can make sense to folks for different reasons. Ultimately, the key to investing is to get invested and stay invested – how you get there is up to you I believe.
Best wishes to you,
Good article Mark. People need advice to manage their investments, and seeing these stats helps.
I have never been able to sit on cash and wait to invest it. If you believe that yesterday was the best time to invest, then you better do it today. Anything else is timing the market. But in hindsight you wont always be right. If you invest for dividends like I do, you get paid while you wait for valuations to come back. I just initiated my annual additional lump sum RRIF withdrawals that will be used to fund the TFSA room and some will go into the margin account. As soon as that money is transferred tomorrow or Monday it will go into equities to generate more dividends.
Wise words on the personal finance is personal bit – I’ve mentioned that here from Day 1 since only in hindsight you know what is right.
I actually was thinking about that the other day….FOMO – I should have bought lots of Apple or Microsoft or other 10 years ago but you never know what the future holds.
I’ve already put my TFSA money to work and more to say on that in the coming weeks on the site. Now, I’ll focus on maxing out RRSP(s) and then contributing to taxable. At the end of the day, you try and make good decisions and move on in life.
All the best to you in 2022,
I tend to lump sum amounts up to $30000 at a time. But I do watch where the market for that fund or funds have been over the last month to determine which day is best. I use limit orders and hope for a good buy within the week. If I miss out that week on a buy, I’ll adjust it slightly higher the following week. I feel better if I get it in on a lower day, rather than a higher day. My partner laughs that I’m timing the market and that’s not how it should be. I think it works, as long as I don’t hold out too long to put it in. I’m not waiting for the bottom or anything that foolish.
Wow, good for your Kat – investing $30K at a time is no slouch. Limit orders are smart as well. Ya, I never “wait” for the bottom. I would have been retired 20 years ago if I knew what that was. So would everyone else!
Mark, your support for this version of lump sum investing, I don’t think I understand. This sounds more like saving up for lump sum investing, rather than getting time in the market by dollar cost averaging smaller amounts over time. I noticed you didn’t talk about the version of DCA vs lump sum investing that I do personally. I take 6% of my takehome pay biweekly and deposit it to my RRSP, where I buy free ETFs biweekly. Used to be when ETFs weren’t free to buy at my broker, I’d deposit bi-weekly, but only purchase every few months, once I had enough to average against the broker fees.
If time in the market is better, wouldn’t Kat be better off DCA smaller amounts regularly rather than saving for a 30K lump sum purchase? (Of course maybe Kat gets $30K lump sums amounts as bonuses, in which case I’m way off base). And I understand it depends on what you’re buying, as you also need to take transaction fees into account, and maybe she saves $30K because she wants to buy 10 shares of Google instead of just one. Is there a market simulator like the one you discuss in the article for the version of DCA vs LSI where you buy regularly rather than saving up and buying in a lump sum?
I’m talking about having $6K now – ready to deploy and what you do. $6K invested now or $6K in my TFSA example invested over 6 months.
DCA over many, many years of investing is a form of investing/DCA but that’s not really on the table in this post. It’s largely impossible to invest years of money all at once.
When Kat has a major bonus with $30K, Kat has a choice. Invest all now or invest strategically over time over a set period of months.
This is not about having a bi-weekly, long-term plan to funnel money to your investments over a multi-year period. Most do since cash is never always always at once. I would need to search for such a market simulator myself but I wouldn’t worry about taking 6% of your takehome pay biweekly and depositing it to your RRSP, buying free ETFs biweekly, over a multi-year period. That’s totally the right thing to do and not part of this analysis. Have a read of the Nick M. post and you’ll see more.
My best to you in 2022!
Yes, I did just put in my lump sum for my TFSA this year, and my tax refund cheque goes right back into my RRSP as a lump when I receive it.
My original exposure to the term Dollar Cost Averaging came from the Wealthy Barber, put away money when you get it, rather than saving up larger amounts to invest. I see there’s a subsection in wikipedia for Dollar Cost Averaging describing the confusion, https://en.wikipedia.org/wiki/Dollar_cost_averaging#Confusion so I guess the terms have changed over time. And Nick M. even mentions this in his article “While I have used this definition of dollar cost averaging previously (see this post), this is not the dollar cost averaging I am referring to in this post.”.
When I first learned of DCA, it was in the context of putting away money as you get it, rather than saving up lump sums. Now it’s investing a lump sum over time, instead of as a lump. Maybe now the term I think of as DCA is now continuous automatic investment, and as you mention that’s preferred to saving up large sums for investment in lumps. Expressions change over time, and I guess I still think of DCA the way I first learned of it, and to see all articles saying invest in lump, don’t DCA, provides me with confusion.
Ya, I’m not speaking about bi-weekly long-term, multi-year contributions in my post either. I mentioned as much.
We are determining the difference between having cash now, investing a lump-sum vs. spreading out that cash over time.
Using a long-term, continuous, automatic way to move cash savings to investing is perfectly normal and reasonable for most but not the subject of this debate 🙂 I hope this helps with the context of the post and Nick’s reference as well. To your point, terminology and what you mean by terms if very important for context since not everyone has the same, univeral def’n.
In 2015, when I downsized my home and moved back to my rural hometown, I took the 100k capital gain and LSI into topping up the TFSA and nonreg accounts. I didn’t want to overthink and give into temporary temptation to treat myself to frivolous consumerism.(ie.new car) I just ripped off the bandaid and made the deposits. Then I thoughtfully put the $ to work.
The goal was to retire asap and this plan was my ticket to freedom 55. This plan would have NEVER happened without MOA’s wise words and voice in my head. Thankyou Mark. Happy New Year from the warm sunny beach in Mexico!
In hindsight Bonnie, what a great move – LSI into TFSA and taxable. If I got a sizeable lump sum, I anticipate I would max out TFSA (if not yet done), max out RRSP (same) and then plow anything into taxable. Our mortgage is very close to being dead so that would be my order.
Ticket to freedom 55 sounds amazing and I hope to join you in the coming years. Enjoy the beach, very jealous since we had to cancel our trip to Punta Cana. :(((
Happy New Year back!!
Excellent post, Mark. Love that calculator. And if your readers haven’t read that Nick Maggiuli post, I highly recommend following that link. He does excellent research.
This is a very tricky issue for all investors who have a significant amount of cash. Even with my knowledge and experience, I still get anxious when investing lump sums! And I will admit that I have held cash for long periods of time, waiting for it to feel right, only to suffer the opportunity costs of not being invested.
A third option to consider that I have found very useful is asset allocation adjustment. If you’re worried that valuations are high, don’t sit in cash, but allocate more money to bonds (I use real return bond funds these days) rather than equities. At least you’re invested in something which, in my experience, sidesteps a big psychological hurdle. You can then move toward your target asset allocation from there.
Absolutely Matt – I too have and probably will in the future – struggle with any lump-sum payment. It has to “feel right” as you know…
Interesting take on real-return bonds liked to rates. A good idea for some for sure. Thanks for the addition since that might help some.
All the best,
I have been on both side of this situation. I think it really comes down to the purpose of the investment. If you are in for the long hall, then LSI is better. Simply because once its invested, the returns start. If you have any anxiety over market fluctuations, then use DCA. I have been tracking the value of my investments weekly since 2019. The value fluctuations are incredible week to week. If this is something that would make an investor panic, then DCA the funds.
Yes, when the volatility is too much for some investors to handle, I no have concerns with DCA approach. I’ve done that myself in the past for that reason. Thanks for your comment Johnny.
I think it’s not exactly one or the other, but both. When the market is high as it is today, there will be less good stocks offering a reasonable yields, therefore you’ll need to be more selective, or even wait. Even today though, if I found a good stock offering a good yield, I’d invest a lump sum. For my dividends I always reinvest and take advantage of DCA.
Ya, DRIP is a form of DCA I believe but in this context, the DCA means fresh money invested over time (as in months) vs. putting lump sum in right now.
DCA is form of saving for sure, i.e., investing $100 per month for decades but this is not the premise of the post but I absolutely know where you are coming from.
BTW – I hope to send some initial interview questions your way soon, by end of month, just been busy 🙂