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.”
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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.
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Discussion
I seem to be missing something here. As I understand the analysis, the investor had $58,000 on day one. In one case he invested the entire 58K. In the other he invested 10K and hid 48K under the mattress and pulled out 1,000 each quarter and invested it. Wouldn't most investors keep the funds not yet in the stock market in what he considered a safe investment that at least provided some return. I didn't run the numbers but it seems to me that the results could change substantially.
posted 11 months ago by Donald from Washington
Donald, you make a very good point. At times during that 12 year period, CD and Money Markets were paying pretty good rates. The investor would have received some interest on his/her money. It should be included in the analysis.
posted 11 months ago by David from Kentucky
I corresponded with Sam about questions posed above. He wanted to make to clear the purpose of the study was not to see how much marginal cash an investor could squeeze out of one strategy versus another, but rather to show the power of compounding (as well as the benefit of avoiding of substantial loss) on an investor's choice of investment vehicles. He further noted that in a near zero-interest rate environment, a money market or a savings account would not have offered much more than security of principal. -Charles Rotblut, AAII
posted 11 months ago by Charles from Illinois
usually the choice to lump-sum or dollar cost is out of our hands. Most people that I know never have a lump of money but save it from month to month so they generally always only are able to dollar cost average unless they just sold out of a position.
posted 11 months ago by Michele from Florida
If we dramatically reduced the time series to 1 to 3 years. Then take into effect short term interest alternatives and tax implication Then comapre many iterations over bull and bear markets. Then, maybe we can start to learn something about this question.
posted 11 months ago by Ted from New Jersey
I used $ cost averaging to rebalance my portfolio to my % allocation for stocks during and after the stock market decline in 2008. It was more comfortable to do than to invest a large lump sum in the stock market not knowing whether the stock market had reached bottom.
posted 11 months ago by Leonard from New York
I ran the numbers and found that over 12 years the amount of interest that would be earned on the $48,000 not invested initially would be $6,148 at the average return of the Vanguard Prime Money Market Fund of 1.95% per year over the past 10 years.
Since 1975 the Vanguard MMF has earned an average return of 5.79% per year. At that rate the $48,000 would have earned $21,053.
posted 10 months ago by Thomas from California
Thomas, Thank you for running the numbers. In calculating your returns, did you assume a $1000/quarter withdrawal of principle from the $48,000 put in the MMF's? Clearly adding the 'risk free' money earned by the $48,000 in the Dollar Cost Averaging scenario is the only meaningful way to compare the two approaches. To ignore, as is suggested by Charles' communication with the author seems silly. That may sound harsh, but what is the point of comparing investment strategies other than to "see how much marginal cash an investor could squeeze out of one strategy versus another". I'm going to speculate that the average reader of AAII already understands the concept of compounding. The article used real world returns for one strategy, but ignored real world behavior for the other. I doubt the author would use his own article for any sort of guidance.
posted 10 months ago by James from Vermont
To: Charles Rotblut, AAII
Do we have anything like Sam Stoval's S&P's Capital IQ database available to us here at AAII?
posted about 1 month ago by William Greene from New York
William,
You can find S&P Capital IQ research on the Markets page at http://www.aaii.com/markets
But we do not publish Sam's research on a regular basis.
-Charles
posted about 1 month ago by Charles Rotblut from Illinois
The message seems to be that if you drop your money in the market when it is low you are likely to do well. Picking one time point hardly qualifies as an analysis of the two alternatives.
posted about 1 month ago by Bruce Oakley from Michigan
Don't forget VALUE averaging == http://en.wikipedia.org/wiki/Value_averaging == invariably superior to COST averaging (and simulations show it has better risk adjusted returns than big-bag investing, too).
posted 27 days ago by Alessandro Martelli from California
This article is totally inadequate and mis-informing. The arbitrary date range chosen has a huge impact on results which is the entire reason to dollar-cost-average in the first place. You don't know what is going to happen in the future as much as you might have reason to expect one thing something else could happen.
In addition to the timing of the initial investment the timing of the dollar cost averaging has a big impact as well.
Suppose I invested lump sum the week before the most recent major crash. Or I invested 20 grand just before, then waited a quarter and put in 20, then another quarter and 18. The dollar cost averaging would have helped tremendously more than likely. It would be even better likely if you waited 6 months between each investment. By timing the initial lump sum before the peak you would immediately get hammered. Same as if you time it before a big gain you would end up better off lump sum probably. But at least you would buy the most with your 20k when it was cheapest.
Not to mention the fact mentioned above that the other money is more than likely not sitting under the mattress and we tend to come into it in small chunks vs large ones.
I can't believe the author's conclusion was drawn off of such a pitiful analysis then posted on here for people to "learn" from. The fact of the matter is this is a huge generalization which could produce totally different results based on timing and that is the argument FOR not against dollar-cost averaging.
-Disappointed.
posted 16 days ago by Jon from Virginia
