Dollar Cost Averaging or Lump Sum
When funding investment accounts, clients are often aware that they could invest it all at once in a lump sum or over time using the dollar cost average method.
Lump Sum /ˌləmp ˈsəm/ noun a single payment made at a particular time, as opposed to a number of smaller payments or installments.
According to Charles Schwab, Dollar cost averaging is the practice of regularly investing a fixed dollar amount, regardless of the share price. It's an excellent way to develop a disciplined investing habit, be more efficient in investing, and potentially lower your stress level and your costs.
We will evaluate the pros and cons of employing both methods in investing.
The Pros and Cons of Dollar Cost Averaging
As previously mentioned, dollar cost averaging means putting your money into the stock market over a period of time, most commonly being weekly or monthly intervals.
One pro of doing this is to take overthinking out of the equation. Investors and clients often check the market daily to determine if now is a good time to pull out or stay in the market.
Additionally, when invested over a long period and regularly making these investments, you will buy when the market is low and high. Over time, your price per share will most likely be favorable.
The cons of dollar cost averaging are relatively simple. In my previous article, I speak about “knowing your number,” which has to do with the stock market. How low is low enough to enter the market from its all-time high, and how high is too high to enter the market?
It is essential to know your number. From January 2021 to April 2023, the market is still down roughly 13-14% from its all-time high. Through this time, it was anywhere from down 25% back up to only down 11%, continuing down and up repeatedly.
To reiterate, the con of dollar cost averaging is missing out on higher gains. Let’s say you have $240,000 to invest and want to split it up into $10,000 invested each month for two years. If you buy when the market is down between 10-15% for a year but then it goes up 10-15% over the following year, then your average share price will be higher, and your return will be lower than if you threw it all in while down 15%.
The Pros and Cons of the Lump Sum Method
As previously mentioned, the lump sum method involves finding the right time for an investor to put their amount into the market in its entirety all at once.
The Pros and Cons of this method surround market timing.
The pro to the lump sum method will be if you act on the lump sum method when the market is down 10% and goes back up for an extended period.
The con to the lump sum method will be if you act on the lump sum method when the market is down 10% and goes down an additional 10-15% over the next two years.
The Future
In conclusion, people have yet to know precisely what will happen in the stock market. Generally, when invested long enough and exposed to the stock market, you will see returns depending on how much stock you have weighted in your portfolio.
The best way to reduce stress, and not worry about market timing, would be to use the dollar cost average.
The best way to know you are buying low is to enter the market at any point when the stock market isn’t at its all-time high. If the market is down 5% and you are comfortable with that, use the lump sum method. If the market is down 10% and you are comfortable with that, use the lump sum method. Even if the market is up 5% from its all-time high, and you think it will go up higher, use the lump sum method if that makes you comfortable.
It all comes down to what you can tolerate.
In general, dollar cost averaging is a good idea for most people because it builds the habit of saving consistently over time. As our friends at Ramsey Solutions always say, investing is about being the tortoise not the hare – it’s a good idea to make a plan to save on a regular basis and stick to it.
The power of speaking with your advisor
As mentioned, everyone has different goals and timelines with their money, so it is important to speak to a Financial Advisor about your specific needs and goals. Please contact one of the Financial Advisors here at Whitaker-Myers Wealth Managers; we would be happy to help you!
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