Should You Dollar Cost Average?

It’s an interesting question. Let’s say you are an investor looking to start investing for the first time. Should you invested a large sum in bulk or purposefully trickle in a little bit every month?

First, we should recognize that not everyone has the luxury of doing this. Most of us in the accumulation phase of life have to invest alongside our biweekly paychecks. There’s no choice except to trickle in our money.

But what if you’re blessed with a sudden large windfall, say from an inheritance, a house sale, or lottery? Is there really an advantage to investing piecemeal or all at once?

Vanguard ran a study back in 2012 about this. By doing historical simulations on different strategies dating back to 1926, they found that lump sum investing outperformed dollar cost averaging in every country they studied over all time horizons, for all mixes of stocks and bonds.

The reason is that on average, the market goes up more than it goes down. Therefore, by maximizing time in the market by investing in a lump sum, we are able to enjoy the market’s rewards earlier. Delaying also means missing out on dividends as they are distributed. The only time that dollar cost averaging makes sense is if we time our investments to match a downturn, but if we knew there would be a downturn, why not delay 3-6 months when the market is lower and then invest lump sum? Dollar cost averaging makes no logical sense.

Vanguard though does note that even though it produces poorer returns, dollar cost averaging can be helpful in calming the nerves of some jittery investors because it reduces short-term volatility. That’s literally the only benefit it provides.

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