When purchasing investments every pay, you are effectively investing as soon as the money is available to you, which is
technically lump sum investing.
This is compared to the idea
behind lump sum investing: the longer you have your money in the market, the more money you will make.
We discussed the difference
between lump sum investing and dollar cost averaging in a previous article and concluded that the best thing to do is to go all in at once.
These illustrations prove that you'll actually make more money if you invest throughout the course of a down market that eventually recovers, than if you invest regularly during a market that instead, grows steadily (again, results are different
from lump sum investing, which will favor consistently upward trending markets):
For the most part,
lump sum investing outperformed dollar cost averaging two out of every three times, «even when results are adjusted for the higher volatility of a stock / bond portfolio versus cash investments.»
Of course, if you DCA instead
of lump sum invest in an up year (and the market is up 66 % of the time) then you'll lose money.
You may also be interested in Rick Ferri's thoughts
on lump sum investing, which contradicts some of what I've argued here.
To clarify before we start, dollar - cost averaging (or DCA) refers to periodic investments regardless of the share price,
whereas lump sum investing refers to investing in one single purchase.
Many studies have used historical data to figure out
whether lump sum investing or dollar cost averaging would have made the most sense and concluded that, on average, you would have been better off investing immediately.
There are two basic investing strategies: dollar - cost averaging and
lump sum investing.
For instance, a $ 120
lump sum invested in the S&P 500 for 10 years had a 20 % higher return than when invested in monthly increments.
(1) We utilize both DCA and
lump sum investing.
We have some other income from bits and pieces of final salary pension schemes, and will have state pensions eventually, but right now we need to start taking an income from
a lump sum invested in S&S.
Dollar - cost averaging (DCA) is often touted as superior to
lump sum investing, but there are many scenarios where DCA may be inferior.
Historical returns show that
lump sum investing has yielded higher returns 66 % of the time.
Lump sum investing can result in better returns because the longer you have your money in the market, the better your returns are over the long run.
If you are hesitating between investing every paycheck or just investing in a lump sum, you can read my thoughts on the best way to invest and
lump sum investing.
However, studies have shown that
lump sum investing has twice the probability of outperforming than dollar cost averaging.
Lump sum investing will give you the highest return over any other method of deploying your money.
However, «
lump sum investing is more likely to outperform dollar - cost averaging for all the scenarios considered.
On the other hand, it's possible that you may end up in a situation that generates the less likely outcome where dollar - cost averaging outperforms
lump sum investing.
Vanguard found that about 67 % of the time
a lump sum investing approach would out perform a dollar - cost averaging approach.
The alternative to this is
lump sum investing (LSI) where you invest all the money into your portfolio at once.
For actually depositing money in, our 401 (k) s are automatically invested, and
I lump sum invest our Roth IRAs and the SEP IRA.
I've read that
lump sum investing in index funds yields a higher dollar outcome than DCA.
(1) We utilize both DCA and
lump sum investing.
Whether you use dollar - cost averaging,
lump sum investing or investing at every pay, you need to have a plan to save and invest.
No comparisons to
lump sum investing with this assumption.
Lump sum investing is probably the best investment strategy because historically the market has risen substantially over time.
In his 2013 Financial Analysts Journal paper (March / April 2013 pp. 34 - 41), «The Arithmetic of Investment Expenses,» William F. Sharpe, Stanford emeritus professor of finance and 1991 economic Nobel prize winner, clearly demonstrated that
a lump sum invested at very low fees -LRB-.06 % / year) was likely to result in 38 % greater wealth after thirty years compared to average mutual fund expenses (1.12 % / year).
Dollar cost averaging (DCA) has lower risk and lower reward than
lump sum investing.
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lump sum investing, retirement savings
The second best choice was
a lump sum invested from day zero.
Lump sum investing, for Buffett and for those who are willing to do the homework, can often give better returns than dollar cost averaging.