Lump Sum Investing or Dollar Cost Averaging?

Lump sum or Dollar cost averaging?If you happen to have a windfall – inheritance, winning the lottery or a large tax refund, is it better to invest it all at once or spread it out over a period of time?

This is one of those questions that does not have a straight answer, and depending on who you ask, you might get a different opinion. But most experts do tend to favor lump sum investing. After all, the sooner you invest your money, the greater your chances of a getting a good return.

I do trust expert opinions, but I’d like to verify them as well.

Two Roads Diverged In A Yellow Wood…

Lump Sum Joe and Risk Averse John, both came across a windfall – $13,568.42 to be exact. Both being sensible investors, decided to invest the money in a low cost index fund. Both chose VFINX that tracked the S&P 500.

But that’s where their investing approaches end.

Lump Sum Joe decided to go with the popular opinion and took an invest-and-forget approach by investing all of $13K at once.

…And Risk Averse John Took The One Less Travelled By

Risk Averse John, being well, risk-averse, decided to go against conventional wisdom and stagger his investments by buying one share of VFINX every month till the money ran out. Not exactly dollar cost averaging, but a similar approach to mitigate risk.

And That Had Made All The Difference.

Both started investing on Jan 1, 1999 and Risk Averse John’s money ran out on Dec 1, 2008. A span of exactly one decade.

  • Lump Sum Joe received 114.27 shares of VFINX for his $13K in 1999 at $118.74/share
  • Risk Averse John had 120 shares of VFINX at the end of 10 years when his 13K ran out

Contrary to what one would expect, Risk Averse John came out ahead of Lump Sum Joe, despite taking on lower risk.

So what happened? Were the experts wrong?

To understand this, we have to take a closer look at conventional wisdom. Why is lump sum investing normally considered better? Because of three factors. Time, which can smooth out market fluctuations, power of compounding, especially true if you use strategies like dividend reinvesting and finally, optimism. You invest hoping tomorrow will be better than today.

Joe and John started investing when times were good, really good. The country had a surplus, 9/11 hadn’t happened yet, the economy was thriving and people were looking forward to the new millenium with hope and optimism. Alan Greenspan, the then Fed chief called the mood irrational exuberance. It truly was if you were invested during that period. Traditional companies were changing their names to end in .com and such moves paid off by boosting stock prices! And hence the name ‘dotcom’ era.

But in a span of 10 years, things went very sour. Bush was elected. 9/11, two wars, unprecedented spending, dot com crash, real estate crash and finally it all culminated to one of the worst recessions in 2008. And that’s about the time Risk Averse John’s 13K ran out, when the market was at one of its lowest point.

In 10 years, the markets instead of gaining, had in fact gone down. The third ingredient – optimism was missing and Lump Sum Joe’s gamble didn’t pay off. Risk Averse John won.


No expert can predict future performance. For an individual investor, here’s what I recommend:

  • Discipline. Have a plan, stick with it, no matter what
  • Diversification. Investors who were all stocks during the lost decade saw their investments crushed as opposed to those who had a mix of Stocks and Bonds
  • Asset Allocation: Spend your energy not in picking individual stocks, but in picking the right asset classes

With many apologies to Robert Frost for my twisted interpretation of his poem The Road Not Taken!

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25 thoughts on “Lump Sum Investing or Dollar Cost Averaging?

  1. Interesting. I recommend the “all in” approach unless an investor is very risk averse or the market is at extremes. Today for example, I would go all in on stocks but leg in on bonds. One problem is that the risk averse investor sometimes has difficulty following through after the market has dropped.

  2. I normally dollar cost average into the market. If I received a lump sum, I would dollar cost average into the market over a year.

  3. The anecdotes about how great dollar cost averaging is, always assume a market that goes down and back up. Your example is a little different in that it only went down during the time period you chose for the illustration.

    We all assume the stock market will go up. You label it “optimism” but it’s kind of the point of investing at all. On average, the market goes up, and so on any given day the market will probabilistically go up. That is, since you are assuming the market will go up in the long term, it follows that you should act as if the market will go up over the short term. Thus, it is mathematically inconsistent to use DCA when you could use lump sum.

    The primary benefit of DCA is psychological. We feel worse about losing money than we do about not gaining money we could have gained. So if a person uses lump sum and the market goes down, they feel terrible. But if they use DCA and the market goes up, they feel only a little bad about it.

    The other psychological benefit of DCA is that it’s what the masses are doing anyways, when they invest in their 401(k). People like to hear about how great DCA is, because that’s what they’re doing, and everyone likes the thing their doing to be the right thing, so that they can feel smart.

    • Definitely. I’m neither for nor against DCA. All I want to point out is that it isn’t black and white. If the markets were to rise, then yes lump sum investing would’ve trumped.

      I chose a period where the markets went nowhere and that’s why conventional wisdom didn’t hold good.

  4. This is bad math. Sorry.

    If you wish to make this an honest comparison you have to take into consideration the dividends that Joe and John received during this period.

    Smaller dividends for John which then slowly grow over time. And bigger dividends for Joe.

    For this to be a fair comparison these dividends would then have to be reinvested in the fund.

    Close to half of the profits from buying stocks like this are from the dividends. Make it fair, and don’t cheat on the math.

    • Thanks Daniel for chiming in. I don’t disagree. Dividend reinvestment has its own advantages. I chose not use DR to keep things simple, the same reason I chose a index mutual fund and not an individual stock or an ETF (commissions/fees) as the focus of this experiment. Not all stocks issue dividends and not all brokerages support dividend reinvestment and alternatively not everyone chooses to participate in DR(calculating cost basis in a taxable account etc.).

      But I do agree with you and I’m sure your intention was to highlight the benefits of DR.

      I’ll even make this the highlight of a future post!

  5. I always love how you analyze things MC. I consider myself to be a low risk investor, but I probably wouldn’t have the patience to follow the steps Risk Averse John took in your example. I might have done two different tranches in one security, but that’s probably the max I’d do for a single investment.

  6. Your point is well taken… Correct me if I’m wrong, but I see it as virtually any investment strategy can be profitable (and to varying degrees) if done consistently, discipline is exercised and risk is well managed… experts notwithstanding.

    Enjoyed it.

    • Exactly! Have a plan, stick with it. The point of this post was not to veer investors from lump sum investing or DCA, but to remove the misconception that lump sum investing is always better.

      Always depends on how the market is going to go – up or down. If it is a downward trend, DCA wins.

  7. If I have a windfall, I would invest the lump sum. I don’t like sitting on a big pile of cash. Actually, I just read a Vanguard study on this subject and they also recommend lump sum investing. Most of the time, the lump sum would come out ahead. If you are unlucky, then you can do worse, but usually lump sum will win.

    • Joe, I read the Vanguard study as well and that’s exactly what I want to disprove – that – let me say it – Vanguard is wrong.

      There is no certainty lump sum investing is better than DCA. Vanguard assumes the market would go up and hence their conclusion.

      Don’t try to predict the market. A Japanese investor from the 80′s would’ve been better off with DCA than lump sum investing.

  8. Interesting point MC! Lump sum is attractive for me because it’s the simpliest move. Deposit it and forget it. It requires discipline to dollar cost average. I guess one could setup an automatic deposit plan, but that’s what my 401k is for, haha!

  9. You write with a great deal of clarity, MC! It’s always better to invest at a set interval to smooth out market volatility. I like that way to made your thoughts so easy to understand for an average investor to understand.

  10. The moral of the story is both investors are well rewarded and way ahead of where the average American is. The main thing is to save and invest any windfalls if possible. I favor the all at once method for most people, since most people wont have the discipline to see a one share a month investment plan through for ten plus years. Better to put it to work right away:}

  11. I like them both but usually use dollar cost averaging. The problem though with a lot of people is that they don’t follow the stocks long enough to catch the down turns. Or they look at the down turns and sell so they never bought more to begin with. If you have a lump sum and are the type that cant hold on to money I would diversify but spend it all and then DCA over the next few years. If you are able to DCA with a large amount in your cash account i think that works best.

    • That’s why it is important to make this automatic and stick with an index fund rather than an individual stock.

      With automatic buys, you take emotion out of the way and by investing in an index fund, you remove the risk of your investment going to zero which is a possibility with individual stocks.

  12. I do not understand. Did you adjust for annual inflation in case of a Risk Averse John?

    Alternatively if he was buying shares over 10 years span and come out with the better result that Lump Sum Joe, those 90 shares over 9 years did not perform that much…

  13. I came across this theory many years ago too. Since then I do not invest “all in” but pick the stocks I want and invest in them in smaller amounts over longer period of time. I think I can get better results than all in strategy.

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