Dollar cost averaging and lump sum buying are 2 widely used investing strategies
Dollar cost averaging what? But I don’t want average dollars, Change Chumps!!Oh dear.
We’re going to look at a common problem faced by new investors. Let’s say you just stumbled upon $50,000 and you want to buy some ETFs. You log into your brokerage platform, and this is what you’re facing:
Yes that’s right Change Chumps!! I remember that!!! So, like, do I invest all $50k at once or like, smaller amounts slowly?!?Excellent question.
If you want the short and lazy answer:
Dump all of 50k in and buy your ETFs at once. Lump sum magic.
That’s it. Close your laptop and go back to watching Netflix (but click subscribe first!)
But…. Change Chumps?! What’s the longer answer?! I wanna know! I’ve been getting wiser and smarter recently and now I’m empowered to take my financial matters into my OWN hands!!!Wow, you’re surprising me today!
Alright, alright. Saddle up and let’s go over some data.
A while ago our friends at Vanguard ran a study. It’s a quick read and easy to understand, so check it out when you get a minute. They basically ran tests on historical stock/bond market data and came back with results.
Lump sum investing almost always produces better returns
Historically, since markets have gone up overall, it matters more to be invested from the get-go. And the earlier you put your cash to work, the better. Their test shows that it didn’t matter if you were in the US/UK/Australia:
- Lump sum investing returns almost always prevailed, by 2.39% in the US, and 1.45% in Australia
- It worked across all asset allocations! (100% stocks or 100% bonds)
This is a good strategy to follow if you just want to minimize time spent managing your assets and if you pay little attention to downturns.
Dollar Cost Averaging (DCA) is good for psychology and protects against market downturns.
On the other hand, DCA also has built-in psychological benefits. This is the strategy I use.
If you dedicate a portion of your regular paychecks to investing then you are effectively doing this method.
Ever bought some expensive sh*t like a watch or a purse and felt buyer’s remorse as you walked out the store? What if you could’ve paid in installments of 20%?
That’s how dollar cost averaging works
Say you’re investing 50k and you’re scared of clicking that Buy button. By buying at regular intervals, you could:
- Divide up 50k into smaller amounts of 2.5k
- Buy in 2.5k weekly
- You’re done after 20 weeks
- Try not to take more than 1 year
- If the market goes UP during that period, then you’ll still capture most of the gains (but not as much as lump sum cause you’re buying at higher prices weekly)
- If the market goes DOWN, then you’ll be getting in at lower prices (discounts!) weekly.
Wait… Change Chumps!!! So… You’re telling me to BUY as the market is TANKING?Correct.
S***!! But who does that?! And what if I lose money?!Disciplined investors do that, because they execute the strategy with no emotions and they also accept the risks involved.
But, and… The media is saying it’s the end of the world! And my Uber driver is saying “Sell! Sell! Sell!”F*** ’em. Seriously. They’re not paying your bills and they don’t know your strategy.
Buying in during a tanking market will FEEL scary and like you shouldn’t do it. I’ve done it recently as of December 2018. You MUST learn to ignore the screaming Chumps around you. You MUST stick to the strategy and the schedule you have set for yourself. Buy like clock-work, without emotions. No if’s and but’s.Never bring emotions to the investing table. That’s how professionals execute.
Not convinced? Here’s how the folks at Millennial Revolution kept executing DCA on their portfolio during the 2008 downturn and how they made money coming out of it while all of Wall Street took a shit.
Anything short of executing your DCA strategy and you will find yourself trying to TIME THE MARKET. Which brings us to my 3rd point.
Time in the market matters more than timing the market
Read that heading again, and again. Get it?
I made this mistake FOR YEARS. For years, I knew I “should be investing” and I knew the steps. But I hesitated. What if I lose money? All that time wondering and being unsure means that I sure lost a lot in opportunity cost!
Our role as long-term investors is to reap dividends for years and years to come. Consequently, getting in earlier is better so that cash starts flowing in and returns compounding. On the other hand, trying to buy at lows and sell at highs is nice, but not necessary with this longer horizon strategy.
In summary, lump sum investing trumps dollar-cost averaging.
More importantly the strategy you choose should be the one suited to your psychology and the one you will execute the best. Sit down and think about the following:
- Do you tend to lack discipline? Do you like to “set-and-forget”? Lump sum may be for you.
- Do you like to take your time? Do you like discounts? Can you tune out media noise? DCA may be for you.
I DCA all of my holdings. What about you?
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