The lump sum or monthly dilemma
When it comes to investment timing there are generally two recommended strategies – either invest all the cash immediately, or break up the total amount to invest in regular installments. For example, if you receive a $12,000 bonus on January 1st, should you put all $12,000 into the stock market as soon as possible, or invest $1,000 per month over the course of the entire year?
The answer, statistically speaking, is to invest the entire amount right away. This is because the stock market rises about 3/4 of the time over a typical 1 year period. So a pattern of investing as early as possible, will over time, yield lower buying prices than dollar cost averaging which spreads the capital over the course of 12 months.
However, the difference in performance isn’t very dramatic. Investment management company Charles Schwab published a study comparing these 2 strategies along with a few other ones. They gave $2,000 at the beginning of every year to 5 hypothetical investors, each with a different timing style. They are as follows.
- Timing the market perfectly by investing the full $2,000 at the stock market’s lowest point of the year, every year.
- Invests the $2,000 at the very beginning of each year.
- Uses dollar cost averaging, dividing the $2,000 evenly by 12 and investing once a month.
- Timing the market in the worst way possible, investing $2,000 at the peak of the market each year.
- Investing in government T-Bills and other cash equivalents that are safe instead of the stock market.
Here is how much money each investor built up after 20 years.
As we can see, investing a lump sum as soon as possible yields slightly better results than splitting up the amount and investing gradually month by month. 🙂 This is true using older periods as well. The study further analyzed all 68 rolling 20-year periods dating back to 1926. In 58 of the 68 periods, the rankings were exactly the same.
In conclusion, if you plan to invest in the stock market, your best move is to invest the entire amount immediately. Don’t split up your capital to gradually invest it over time. Dollar cost averaging will probably set you back instead of help you. The earlier you take the risk with your money the more time it will have to grow. 🙂
Here are some questions to sum up today’s blog post.
- The TSX just reached a record high last week on Sept 17. If you have money to invest now, should you wait for a small pullback before jumping in?
Answer: The data would suggest no. Believing that lower stock prices are just around the corner is a terrible mindset to have, financially speaking. As a case study, the Dow Jones index in the U.S. reached over 120 all-time highs just in the 2010s alone so far. It’s quite common for record highs to be followed by more record highs. The last investor in Charles Schwab’s study stayed out of the market and ended up with the smallest portfolio after 20 years. Many renters in Toronto missed out on the real estate boom over the last 2 decades because they were waiting for home prices to drop since 2000. Waiting for any correction is generally not a good idea.
- Are there times when it’s better to dollar cost average rather than invest immediately?
Answer: Yes. If you don’t already have a large pile of money saved, then dollar cost averaging (DCA) is better than waiting until you save up enough for a larger lump sum investment. The simple lesson is the sooner your money is invested, the better. 🙂
- Does timing the market work?
Answer: In most cases, no. In the study above, after a 20 year period, the perfect market timer amassed only 6.5% more wealth than the investor who put money to work right away. Market timing can easily go wrong. The worst market timer in the study ended up with 12.6% less than the lump sum investor. So the risk is not the worth the potential reward to time the market.
Random Useless Fact:
The goal of golf is to play as little golf as possible.