Invest in Waves or in One Chunk? Dollar-Cost Averaging Versus Lump-Sum Investing

Here's an interesting discussion on which is a better investing option -- dollar-cost averaging or lump-sum investing. In other words, if you have an amount of money you want to invest, is it better to trickle it in over time or dump it all into the market at once? Here's what the piece linked above advises:

Over short periods as well as long, investing lump sums is the equal of dollar-cost averaging, except in those rare times when the market is going straight up, when lump-sum investing does better.

"At our firm, we tell clients that there is no difference," says Paul A. LaViola, the vice president of RTD Financial Advisors in Philadelphia. "However, emotionally, it can make someone feel better if they DCA when the market is going down or they are unsure about the market."

Now, of course, this assumes that you have one big lump sum to invest (which most people don't have). So, practically speaking, most people (for example, those with 401ks) invest using dollar-cost averaging. Or I guess this could be called lump sum investing too -- since they invest the entire amount they have available each month at one time. It's kind of circular logic/discussion, and I'm starting to get confused going through what exactly these two options are.

Anyway, here's my take and what I do:

1. Each month, I contribute to my 401k and that money is invested immediately.

2. Also each month I have money go from my checking account to Vanguard where it's invested immediately.

3. At the beginning of each year, I have several lump sum contributions -- to IRAs, Coverdells, and 529s. I invest these immediately.

4. Overall, my plan is to get the money into the market as soon as it's available (to start the compounding process) -- whether that means on a monthly basis or for those bigger portions at the start of each year.

How about you? How do you invest your money?

Comments

[LC]

I do the same thing as you. I'd rather get my money for the Roth all in at the first possible date. So even though this is technically a lump sum (compared to the monthly 401k contributions), over the 30 years of work, it really is kind of like dollar cost averaging since you are doing some each year. I guess it all depends on how you look at it, and if you are in the market for the long term (which you should be), there really is no difference.

[Edmund]

"1. Each month, I contribute to my 401k and that money is invested immediately."

this is kind of off topic. By law, your 401k administration does not have to invest your money immediately. Many (like mine) keeps the money for a couple of weeks before they invest it. At least for my 401k administrators, they make millions every year just off of the interest alone!

[Mark]

@Edmund - My old job used to do that as well, it'd be a few weeks before they invested it. At my new job it gets invested immediately.

I invest in my 401k every 2 weeks with the my paycheck deductions. I used to contribute to a Roth but have held off since my current job will be severed June 1st. I have 4 months of emergency cash in savings/checking accounts, I'd like to beef that up to 6 before I go back into Retirement and Non-Retirement investing outside the 401k.

[Miss M]

I read something similar before that said if you have the lump sum in hand it's usually better to go ahead and invest it as a whole rather than doling it out in chunks. The reason being the market on average goes up, get it in sooner at lower prices. In my case I have had better luck with dollar cost averaging, the lump sum investments were made at bad times.

[JimmyDaGeek]

Financial advisor Ric Edelman (I have no connection) discusses this in his book "The Truth About Money" (Chap 46?) that you can get out of the library. He comes to the conclusion that it makes no sense to DCA a lump sum since the market is on a long-term uptrend. So if you are putting money into the market, you want to take advantage of that uptrend now, not later. Along with this suggestion, he advocates investing a lump sum in a diversified portfolio.

[Bobby]

I think this sort of decision making generally occurs when you come into a windfall, lottery with a lump sum payout as opposed to say 50,000 over 20 years. I always heard to take it lump sum, pay the taxes, keep 10% for yourself and invest the rest.

[Russ]

Here's a great paper with historical evidence on why it's best to invest in one chunk: http://www.equiuspartners.com/pdf/Plunge%20In%20or%20Wade%20In.pdf

It's written by a fee-only financial advisor, Jeff Troutner.

However, as acknowledged by the advisor from RTD, you must consider the emotional/psychological elements of such a decision.

[Kevin @ The Money Hawk]

I would say that if you have a lump sum, invest it at once and let it go. However, if you need that money tax sheltered, you're going to need to invest in $5000 increments (or whatever the current limit happens to be).

If you're already maxing out a roth or an IRA, I'd just go ahead and dump the whole thing into different index funds and let the market do its job.

[guinness416]

I struggle with understanding this, and will be interested in the discussion. I do invest regularly when I get paid once a month, but also get a fairly large bonus every November. I use this to fund my RRSP (sort of canuck 401k?) to its max, but always wonder if I should dribble it in over 4 months rather than invest upon getting the bonus.

[kf]

I invested a lump sum into an S&P500 index in my Roth IRA at the start of 2008...it's going to take many years to recover from that. Luckily I have about 30 years left.

[Mark]

Dollar Cost Averaging is the best way to go....you can't time the market.

HOWEVER, if you have a large sum of cash in a bank CD, money market, or other low-interest portfolio, take whatever you can, minus your emergency fund, and invest lump sums into stock mutual funds when everyone else is panicking.

[Jim]

If you are in the market long term then investing a lump sump once a year consistently for say 20 years is basically dollar cost averaging (DCA) over a long term period. So if you're looking at funding a Roth IRA for example then I think its OK to dump $5k in every January.

I favor DCA in general since it takes the risk out of the short term ups and downs and gives you an average result. If you're doing lump sum investments then you're more likely to be tempted to time the market.

One benefit DCA is that it can be done automatically and keeps emotional reactions to the markets ups & downs out of the equation. If its automatic then it also keeps you from procrastinating.

Jim

[Matt]

I think the reason dollar cost averaging is a little confusing is because people are thinking about it in relation to their ongoing 401k contributions or other retirement savings. You are pretty much dollar cost averaging (over many many years) if you take a chunk of money out of your paycheck and invest it on a regular basis.

Typically, as I've heard DCA discussed, it's when someone gets a windfall (inheritance, gift, etc) and they want to decide how to put it into the market. It's hard, in that situation, to not feel like you're timing the market if you just shove the 20k you just got from Aunt Ida into an index fund all at once when you typically invest $200 every month. So, DCA basically lets you walk into the shallow end rather then dive in the deep end.

Here's an article/opinion about it: http://money.cnn.com/2008/01/15/pf/ask_the_mole.moneymag/index.htm

I think I'd tend more towards just plunking it in, but this feels a bit like preference to me, hard to know with any certainty which will work out better.

[S]

This is kind of a newb question but the 5000 roth ira allotted per year... is that until December or until April 2009?

If its april 2009, then when did it start? April 2008?

[FMF]

S --

"You can make a contribution for the 2008 tax year as early as Jan. 1, 2008 and as late as April 15, 2009. (The same rules apply to traditional IRAs.) However, it's best if you make Roth IRA contributions as early in the year as possible. That way, you can start taking advantage of tax-free growth sooner rather than later."

Source: http://www.smartmoney.com/personal-finance/retirement/roth-iras-you-wanted-to-know-7967/