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What is Dollar-Cost Averaging vs. Lump Sum Investing

Written By Karissa Goessl June 7, 2023

What’s Best for Your Investment Portfolio?

Dollar-cost averaging (DCA) is an investment strategy that involves investing a fixed amount of money into an asset over a set period of time, regardless of the asset’s price fluctuations. For example, if you invest $1,000 per month into a mutual fund, you’re using a dollar-cost averaging strategy. The idea behind the DCA strategy is to reduce the impact of short-term market volatility on your investment returns. By investing a fixed amount of money over time, you buy more shares when prices are low and fewer shares when prices are high. This tends to help smooth out your investment returns over the long term.

At Williams Asset Management, we’ve worked with countless clients that have come into substantial and sudden wealth through inheritances, business sales, and long-term employer incentives, among other windfalls. All in an effort to implement a comprehensive investment management strategy that meets our clients’ needs. Throughout our in-depth process, one question often arises whether it’s better to invest a lump sum all at once or use a dollar-cost averaging strategy. Read on for a discussion of both strategies and the pros and cons associated with each.

What is Dollar-Cost Averaging?

The idea behind the DCA strategy is to reduce the impact of short-term market volatility on your investment returns. By investing a fixed amount of money over time, you buy more shares when prices are low and fewer shares when prices are high. This tends to help smooth out your investment returns over the long term.

The Pros of Dollar-Cost Averaging

1. Reduces Risk: DCA reduces the risk of investing a lump sum all at once, which can be risky in a volatile market. By investing a fixed amount of money over time, you can avoid investing all your money at a market high and potentially losing a significant portion of your investment.

2. Automatic Investing: DCA is an automatic investment strategy that can be set up with most investment accounts. This means you can “set it and forget it”, which can be beneficial for those who don’t have the time or desire to actively manage their investments.

3. Disciplined Approach: DCA is a disciplined approach to investing that can help you stay on track with your investment goals. By investing a fixed amount of money every month, you’re building your investment portfolio in a consistent and disciplined way.

The Cons of Dollar-Cost Averaging

1. Missed Opportunities: DCA can result in missed opportunities and lower returns if the market consistently increases. If you’re investing a fixed amount of money every month and the market is going up, you may miss out on potential gains by not investing a lump sum all at once.

2. Fees and Expenses: DCA can result in higher fees and expenses than investing a lump sum. This is because you’re making multiple transactions over time, which can potentially result in higher transaction fees and expenses.

Lump Sum Investing

Lump sum investing simply means investing a large amount of money all at once. This can be beneficial if the market is at a low point and you can buy assets at a discounted price. However, lump sum investing can be risky if the market is at a high point and you invest all your money right before a market downturn. The obvious issue is that nobody knows if a low point is going to go lower, or if the markets are going to continue to reach record highs. Only with the benefit of hindsight will you know if investing all at once was a good decision.

It is Not Always a Financial Decision

At the beginning of 2022, which, as we know, turned out to be a difficult year for equities and a historically tough year for fixed income, we recently had a client who received a $10 million inheritance (majority of it liquid) and was interested in investing it all at once. However, after discussing the pros and cons of DCA vs. lump sum investing with our team of advisors, and how this inheritance impacted her own financial plan, she decided that DCA would be the best approach for her, especially since the funds were inherited due to the premature passing of her parents. By investing a fixed amount of money over time, we were able to reduce the risk of investing all her money near a market high and potentially losing a significant portion of her inheritance.

Dollar-cost averaging and lump-sum investing are both viable investment strategies, and the best approach for you depends on your individual financial situation and goals. Our team’s financial advisors have been serving the Maryland area for 20+ years, and in doing so, have helped our clients understand the many factors that go into determining DCA or lump sum investing to empower an informed decision.

One last thought: while the amount, source of funds, and market environment surely play a role in the decision of whether to DCA or invest funds as a lump sum, financial goals should also be a consideration. For example, if the purpose of the funds is for a goal that is 50 years from now, the impact of the returns over the next 12 months would be somewhat muted compared to a goal that is 10 years from now. Our CERTIFIED FINANCIAL PLANNER^® professionals can help with determining how your financial goals should be considered with making investment decisions.