Should You Dollar Cost Average or Lump-Sum Invest?
by Sam Stovall
As of February 17, 2012, the S&P 500 index has risen more than 23% off of its October 3, 2011, closing low.
Some investors, who were convinced that history would not repeat itself by seeing the “500” advance 23% in the six months after concluding a near-miss or baby-bear market, still have a lot of money on the sidelines. They are probably now asking themselves, “Should I throw in the towel and invest it all, or put my money back to work gradually since the market may correct any day now?” This dilemma is timeless for investors, who are basically asking if they should dollar cost average (invest a fixed amount at equal intervals) or lump-sum invest. The correct answer? “That depends.”
Testing the Approaches
To try to answer that question, I analyzed both approaches using two similar investment vehicles—the S&P 500 index and the S&P 500 Dividend Aristocrats index—from December 31, 1999, through February 17, 2012, to see which would have been the better approach. I had one hypothetical investor make an initial investment of $10,000 in the S&P 500 on December 31, 1999, who then added $1,000 at the start of the subsequent 48 quarters (for a total investment of $58,000). As of February 17, 2012, this investor’s portfolio grew to $75,611, including dividends (Figure 1). The second hypothetical investor, who plunked down all $58,000 on December 31, 1999, and let it ride, now has a portfolio that is worth $67,247. So in the case of the S&P 500 index, it was better for an investor to dollar cost average than it was to make a lump-sum investment.
But the same did not hold true when using a different investment vehicle. When this same dollar-cost-average investor made an initial investment of $10,000 in the S&P 500 Dividend Aristocrats index on December 31, 1999, and then added $1,000 in the subsequent quarters through February 17, 2012, their portfolio grew to $108,441, while the lump-sum investor ended up with $148,332. So in this case, it was better to make a lump-sum investment than it was to dollar cost average.
Why the difference? At first blush, the answer lay in the benefit of compounding higher dividend yields, since I also found that the lump-sum approach outperformed the dollar cost average approach for such other high-yielding S&P indexes as the S&P 500 High Quality Rankings index, the S&P 500 Low Volatility index, and the S&P U.S. Preferred Stock index.
Comparing Sector Performance
However, I began to question a high dividend yield as the sole reason for the outperformance of dollar cost averaging versus lump-sum investing when I crunched the numbers for the sectors in the S&P 500 over the same time frame (Table 1). If a high dividend yield were the sole reason, then why was it better to dollar cost average with the telecommunications services sector, yet better to lump-sum invest with the energy sector?
Upon further analysis, I concluded that the decision had more to do with how well each sector rode the undulating waves of bull and bear markets since 2000 in general, and how big of a hit it took during the bear of 2000–2002 in particular, rather than the standard deviation of monthly returns during the prior 12+ years. In seven of 10 cases, it was better to be a lump-sum investor than to take the more gradual dollar cost average approach, as the difference between the ending values ranged from less than 5% for the financials and industrials sectors to more than 20% for the consumer staples and utilities sectors, and in excess of 45% for the energy sector. By looking at the total returns during each of these beatings and bounce-backs, I found that the dividing line between dollar cost averaging and lump-sum investing, in eight of 10 cases, was determined by a descending sort of all sectors based on their cumulative total returns from 2000–2012. Only in the case of the consumer discretionary and financials sectors was this not true, possibly because of their relative outperformances during the bear market of 2000–2002 and comparative dividend yields.
|
S&P 500 Sector |
Std Dev |
Cur Yield (%) |
Dollar Cost Averaging ($) |
Lump-Sum Investing ($) |
% Dif |
Bull & Bear Returns (%) | 2000–2012 | |||
|
2000– 2002 |
2002– 2007 |
2007– 2009 |
2009– 2012 |
Total Return | ||||||
| (%) | ||||||||||
| Energy | 20.88 | 1.9 | 132,430 | 193,781 | 46.3 | -15.7 | 274.6 | -42.7 | 80.3 | 226.4 |
| Consumer Staples | 11.77 | 3.0 | 101,653 | 126,865 | 24.8 | 24.8 | 61.9 | -25.9 | 76.3 | 163.8 |
| Utilities | 17.17 | 4.2 | 92,579 | 115,042 | 24.3 | -32.1 | 175.5 | -37.7 | 58.4 | 84.6 |
| Health Care | 14.29 | 2.3 | 78,922 | 91,258 | 15.6 | -6.9 | 53.7 | -34.6 | 67.8 | 57.1 |
| Materials | 22.84 | 2.1 | 99,078 | 113,156 | 14.2 | -16.7 | 178.6 | -55.6 | 115.8 | 122.4 |
| Industrials | 19.85 | 2.4 | 83,033 | 87,071 | 4.9 | -29.5 | 122.9 | -58.3 | 131.7 | 51.8 |
| Financials | 24.14 | 1.7 | 45,516 | 47,157 | 3.6 | -11.2 | 84.8 | -76.5 | 105.7 | -20.6 |
|
S&P 500 |
16.50 |
2.1 |
75,611 |
67,247 |
-11.1 |
-43.8 |
108.4 |
-50.9 |
97.1 |
15.9 |
| Consumer Disc. | 19.88 | 1.7 | 86,845 | 76,469 | -11.9 | -36.3 | 70.3 | -51.0 | 157.7 | 36.9 |
| Telecom Services | 22.18 | 5.8 | 68,499 | 36,405 | -46.9 | -73.9 | 166.9 | -41.8 | 57.1 | -36.4 |
| Info Technology | 28.49 | 1.1 | 77,153 | 36,144 | -53.2 | -80.3 | 151.8 | -50.6 | 123.5 | -45.1 |
| Source: S&P Capital IQ. Past performance is no guarantee of future results. | ||||||||||
Looking Ahead
So what does this mean going forward? Lump-sum investing is probably the better way to go, in my opinion.
Should the U.S. equity markets continue to suffer through a secular bear market for the next few years, as they have since 2000, the consumer staples, energy, health care, and utilities sectors may again be superior performers, due to their relatively high dividend yields and defensive characteristics. Each of these groups showed better results from the lump-sum approach than from dollar cost averaging since 2000. Yet if we find that the S&P 500 is in the embryonic stage of a new secular bull market, we will probably look back and conclude that it would have been better to lump-sum into the cyclical areas.
So while the answer is still the same—lump-sum investing over dollar cost averaging—the outstanding question is whether a secular bull or bear awaits.