Invest All At Once or Bit by Bit?
Key Takeaways
Lump-sum investment strategies beat cost averaging (dollar cost averaging or DCA) investment strategies more than two-thirds of the time, according to research on historical market cycles.
However, cost averaging works well to minimise regret and helps investors who are loss averse to stay seated especially if markets are on the decline over the short-term — especially in 2022.
Cost averaging also has the ability to outperform only when it is implemented in a declining market — so it boils down to luck and market timing.
Neither option is a “right or wrong” answer — the strategy that you choose that enables you to hit your goals is the correct one.
Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.
— Paul Samuelson
Whenever you have a sum of money to invest, there are many different things to consider. Usually you start off by assessing the return you need in order to achieve your end result, and also if the risk is palatable. Then, you will need to research the vehicle or asset allocation that is required to implement your strategy. However, one decision that regularly stumps a lot of people is whether to put all of their money in at once, or to phase it in over time — essentially a form of dollar cost averaging.
After all, perhaps your money was due to an inheritance, the sale of a family business that was built with hard work over time, or a bonus payment. The money is precious to you and you would loath to invest it only to see its value decline dramatically during a market downturn.
Let’s take a look to see which works better but the main learning lessons from latest research by investment giant Vanguard shows:
Lump-sum investment strategies beat common cost averaging investment strategies two-thirds of the time, according to historical and simulated market data. So for many investors who are focused on wealth accumulation and have time on their side, this is the optimal choice.
Cost averaging strategies, whilst sub-optimal in terms of returns, are still a decent choice for investors who are very risk averse and fear losses, and will still be a better outcome than holding cash or very safe instruments like T-bills over an extended period of time.
A comparison of lump sum investing and cost averaging shows that lump sum has does better, hence suggesting you are usually better off investing immediately instead of holding back a portion. The figure below shows that a lump sum investment does better than a cost averaging strategy nearly 7 out of 10 times. However, investing in any way possible still does better the majority of the time compared to sitting on the sidelines.
What if your portfolio allocation has bonds? The chart below shows that whether you are holding 100% equity, 60% equity or 40% equity with some bonds, a lump sum investment does better than cost averaging — with end results doing much better over a one year period. Only below the 25th percentile does lump-sum start to perform similarly or worse than cost-averaging.
So given the data so far, why should anyone cost-average?
Cost averaging works well to minimise regret and for investors who are loss averse. With this systematic strategy, your money is invested at set intervals without considering the price or what is happening in markets. This helps to remove emotions from the investing process and limits any knee-jerk reactions.
Cost averaging also works well if markets are on the decline over the short-term — especially in 2022 and in every past instance of a market sell-off. If you happened to cost average into the market at the exact moment that a sell-off was occurring then you would outperform on two fronts:
You suffer less losses as you had the ability to buy at a cheaper average price.
You hold more units of the investment so your long term return will be better.
The example below shows two investors with $1,200 to invest. One dollar cost averages $100 a month over 12 months, whilst the other invests all in the beginning. The fund invested was into one of our core equity funds — the United G Strategic Fund during 2015 when the market was undergoing a correction.
You can see during this specific example that the cost averaging strategy has done better both in terms of buying more units and mitigating a large loss over that short period of time.
Assuming that they did not invest further and they held their investments till today, the lump sum investor would end up with $1,640 — a 36.7% gain. The cost averaging investor would end up with $1,756 — a 46.3% gain.
The outperformance by cost averaging only occurs during specific periods and only when the market is trending downwards. As markets go up most of the time, a cost-averaging strategy means that you are buying at a higher average price over the long term.
The data shows that a lump sum investment does better most of the time. However life is usually not in a straight line, and neither are investments.
If entering the market at regular intervals keeps you seated during market turbulence and ensures that you don’t deviate from your investment plan, then that is probably the best choice for you. If you have the guile to enter the market in one go, then the data is on your side. Neither option is a “right or wrong” answer — the strategy that you choose that enables you to hit your goals is the correct one.
If you need more info on how to implement such strategies, come and have a chat with us.
