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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