You might read articles in the consumer press about the wonders of dollar-cost averaging. The basic idea is that instead of putting a lump sum of cash to work in the investment markets all at once, you spread out your investing over a period of weeks or months. That way, if the market goes down while you’re investing, your next scheduled investment will be buying stocks at a bargain.
Unfortunately, the research suggests that dollar-cost averaging is normally a sub-optimal strategy relative to investing a lump sum (if you have one) which tends to produce better investment results.
Dollar-cost averaging does have one thing in its favor: it reduces the risk that you will invest at an inopportune time. If you’re investing when the start date falls right before a dramatic crash or the start of an overall 12-month slump, then investing in stages will turn out to be a winner…but how often does that happen?
One study, by the Vanguard fund group, found that over rolling 10-year periods for the U.S. market between 1926 and 2011, and the UK market from 1976 to 2011, and the Australian market from 1984-2011, lump sum investing generated a higher total return than dollar-cost averaging 67 percent of the time. That makes sense, because the markets are delivering positive returns far more often than they are mired in a bear market. Another study from the Seeking Alpha organization found that over the last 27 years, a 12-month investment in the S&P 500 provided an average return of 8.77%, while using dollar-cost averaging over the same period would have returned only 4.77%. When substituting bonds for cash as the investment of the money not deployed in the market, the dollar-cost averaging strategy came closer to the lump sum average returns, but still posted a lower average return.
This article was written by an independent writer for Brewster Financial Planning LLC and is not intended as individualized legal or investment advice.