Different investing strategies lead to different results. The two most common investing strategies are dollar cost averaging and lump sum investing. While both of them work, there are several reasons why you might want to choose one over the other. In this article, we compare both strategies. Which one works better? Which one should you choose? Dollar cost averaging vs lump sum investing. Let’s settle the score once and for all.
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Dollar cost averaging is an investing strategy where you invest a fixed amount of money at fixed intervals. For example, you might set aside $500 every month and invest it on the last day of the month.
If you prefer a higher dollar cost averaging frequency, you can invest smaller amounts every week or day.
The benefit of dollar cost averaging is that you are buying regardless if the market is high or low. Some days you might buy when stocks are overvalued and other days you’ll buy when prices are down.
Over a long enough time horizon, the average price at which you bought will neither be excessively high nor low. Since you’re buying on up and down days, you’ll end up with an average price.
If you’re dollar cost averaging, you need to choose a frequency that works for you. You can invest manually on a monthly or weekly basis. But if you prefer investing daily, you’ll need an automated way of dollar cost averaging.
There are certain platforms that allow you to invest fixed amounts of money at predetermined intervals.
For example, M1Finance allows you to automate your stock and ETF investing.
With M1 Finance you can deposit a fixed amount of money every day, week or month and auto-invest it. You can auto-invest as little as $10 per day.
Similar to M1Finance, Swan allows you to auto-invest as little as $10 per day in bitcoin.
All you have to do is connect your bank account with Swan and it will automatically deposit the amount you’ve set at a predetermined interval and invest it in bitcoin.
You can then automatically withdraw your bitcoin to a hardware wallet once you reach a certain threshold.
Automated dollar cost averaging takes the guess work, emotion and discipline out of investing. Instead of having to keep track of your investing schedule manually, you can let the software do it for you.
By sticking to investing a fixed amount of money at predetermined intervals, and letting an algorithm do so for you, you’re less prone to acting emotionally.
The best investors are rational and disciplined. This is hard for most people. They tend to buy high and sell low. Automated dollar-cost averaging allows you to be an ice-cold, rational and disciplined investor without actually having to be one.
Read More: Investing In Stocks for Beginners
The downside of a high dollar cost averaging frequency is that you might pay more fees. Make sure you check the deposit and trading fees of the platform you’re using.
Lump sum investing is an investing strategy where you take a larger amount of money and invest it all at once.
The benefit of lump sum investing is that your money spends more time in the market. There is a saying in investing that time in the market beats timing the market.
This means that trying to time the market, such as buying low and selling high, is difficult. Even most experienced investors aren’t able to time the market.
For example, if you are waiting for a market crash to invest, you might be waiting for years. While you’re waiting for a life changing investment opportunity to buy the dip, you are missing out on stock market gains that are happening during the waiting period.
Permabears are investors that constantly think a market crash is around the corner. They usually hold a lot of cash or gold. They are sure the big crash is imminent, allowing them to take all their cash and buy bargains left and right. Once the market recovers, they can make fortunes.
But many permabears have been patiently waiting for a major stock market crash for years. In the meantime, their money lost value to inflation.
Read more: Where to Invest Money to Get Good Returns
Had they prioritized time in the market instead of trying to time the market, they would be a lot better off. The benefit of dollar cost averaging and lump sum investing is that you have money invested in markets at all time.
Both strategies have benefits. Dollar cost averaging makes most sense for people who haven’t save up a significant amount of money.
If you’re only just starting to save money, lump sum investing isn’t an option since you don’t have a lump sum to invest in the first place. In this case, dollar cost averaging is a great way to start investing money.
If you have already saved a significant amount of money, let’s say $10,000 or more, making a lump sum investment is an option.
In this case it’s crucial that you research and understand what you’re investing in. This is also important with dollar cost averaging, but since you are investing smaller amounts over a longer period of time, you have more time to fully understand and research what you’re investing in. In case you are wrong or make a mistake, it’s less painful than if you invest a lump sum.
You can also combine dollar cost averaging with lump sum investing. Let’s say you have some money saved up and want to start investing. You could take your savings and make a lump sum investment in a few different investments that you understand and believe in.
After your initial lump sum investment, you can take your left over savings each month and invest them automatically in stocks, ETFs or bitcoin using dollar cost averaging.
M1Finance and Swan Bitcoin allow you to make both lump sum investments and automatically dollar cost average a certain amount at fixed intervals. This means, you don’t have to change platforms if you decide to combine dollar cost averaging and lump sum investing.
Vanguard conducted a study that compared dollar cost averaging vs lump sum investing. They looked at the historical performance of both strategies in the United States, United Kingdom and Australia.
They concluded that on average lump sum investing outperforms dollar cost averaging.
This confirms the age old saying that time in the market beats timing the market. Gaining exposure to markets as soon as possible is favorable.
However, there are other factors to consider. While lump sum investing outperforms dollar cost averaging most of the time, someone who invests a large amount of money might be more susceptible to act emotionally.
Lump sum investing only outperforms dollar cost averaging if investors act rationally. If you invest $10,000 or $1,000,000 and panic sell when the market corrects, lump sum investing isn’t guaranteed to outperform dollar cost averaging.
If dollar cost averaging provides you with more peace of mind and allows you to invest less emotionally, you might be better off with dollar cost averaging than lump sum investing.
As mentioned earlier, the two strategies don’t have to be exclusive. Investors can combine dollar cost averaging and lump sum investing to get the best of both worlds.
Which strategy wins? When it comes to dollar cost averaging vs lump sum investing, both investing strategies are valuable. The Vanguard dollar cost averaging study proves that lump sum investing performs better most of the time as long as investors act rationally.
But if you don’t have a lump sum to invest or prefer the peace of mind and discipline that comes from investing fixed amounts at predetermined intervals, dollar cost averaging might be better suited for you personally.
Regardless of the strategy, it’s important to do your own research and understand what you’re investing in. Whoever you think wins the fight between dollar cost averaging vs lump sum investing, make sure you manage your risk accordingly.
Combining both strategies and using lump sum investing to start out and dollar cost averaging to continuously invest your savings might be the best approach.