If you have some money saved, and you're ready to get started with investing, you'll face a common dilemma. You could invest that money all at once. This is known as lump-sum investing, and it gets you fully invested right away.
Or, you could invest that money in fixed increments. Instead of putting $3,000 into the market immediately, maybe you invest $1,000 a month. This is known as dollar-cost averaging.
New investors often wrestle with this decision. Neither option is a bad choice, but there is one that tends to perform better.
Lump-sum investing is usually the better choice
There has been plenty of research done on this subject, so we have an answer on which investment strategy is better. Lump-sum investing outperforms dollar-cost averaging about two-thirds (68%) of the time, according to Vanguard.
Vanguard measured results for each strategy using market data from 1976 through 2022. It compared one-year returns on a hypothetical $100,000 investment. Money was either fully invested from the beginning (for the lump-sum method) or over the first three months (for dollar-cost averaging). It ran 10,000 scenarios, using different asset allocations and time periods.
Vanguard found that "in most historical market environments, investors would have been better off investing the lump sum all at once." This method outperformed dollar-cost averaging by a median of 1.2% to 2.2%, depending on asset allocation.
Dollar-cost averaging is a good alternative if you're risk-averse
Even though lump-sum investing generally works out better, there is a valid reason to go with dollar-cost averaging.
Imagine that you've saved up $10,000, and you invest it all. Then, the market goes into a freefall. It loses 10% over the next few months, and your portfolio is now worth $9,000. Do you panic, constantly check your brokerage account, and consider cutting your losses? Or do you remain calm and remember that historically, the market has always recovered?
If the thought of losing money terrifies you, then you may want to go with dollar-cost averaging. The advantage with this method is that you're more likely to avoid big losses. Even if the market declines after you invest, you haven't invested all your money yet. You'll still have cash you can use to invest at a lower price while the market is down.
Dollar-cost averaging is also a good choice after you've gotten your initial money invested. Investing shouldn't be a one-time thing. To get the best results, it's important to make investing a habit. Since dollar-cost averaging is simply investing a set amount regularly, it's a great long-term strategy. You can likely set up automatic investments through your brokerage or retirement accounts so you don't need to remember to do it.
There's no wrong answer
Lump-sum investing and dollar-cost averaging are both good strategies when starting out as an investor. The difference in performance isn't significant enough to make either the clear best choice, so pick whichever you're comfortable using. The fact you're investing is what's most important, not the method you choose.
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