A financial windfall like an inheritance or salary bonus can be a wonderful opportunity for investing. But what’s the best way to invest your newfound wealth: all at once or little by little?
New research from Vanguard suggests that you’re often better off investing a lump sum compared to taking the more methodical approach of incrementally investing your money. Investment and wealth planning strategists from Vanguard found that lump sum investing outperformed dollar-cost averaging nearly two-thirds of the time between 1976 and 2022. Here’s a closer look at the research and what it could mean for you.
Need help investing? A financial advisor can build you an investment strategy tailored to your needs and financial goals. Find an advisor today.
Lump Sum Investing vs. Dollar Cost Averaging
First, let’s briefly review the two investing strategies, how they differ and what each emphasizes.
Lump sum investing. As its name suggests, this strategy involves investing an entire pool of assets at once. Lump sum investing maximizes your time in the market – and your potential growth – but it can also can expose you to larger declines in your portfolio’s value (known as drawdowns) when the market drops.
Dollar-cost averaging. Unlike lump sum investing, dollar-cost averaging is a systematic approach for consistently investing a fixed dollar amount over a given time period. Regular contributions from your paycheck to your retirement account are a common example of dollar-cost averaging. The strategy doesn’t offer the same upside as lump sum investing, data shows, but it can limit your losses in a market downturn.
Advantages of Lump Sum Investing
Megan Finlay and Josef Zorn, strategists for Vanguard’s Enterprise Advice Group, found that lump sum investing outperformed dollar-cost averaging 68% of the time between 1976 and 2022. During those years, dollar-cost averaging did produce higher returns than simply holding cash, though. However, the strategy consistently lagged behind lump sum investing across a variety of market conditions and asset allocations.
The Vanguard strategists also found that the higher an investor’s equity allocation, the wider the gap gets between the two strategies. Using historical data, Finlay and Zorn calculated annual returns for the two strategies across the following equity allocations:
40/60 portfolios. Lump sum investing produced 1.2% more wealth each year, on average, than dollar-cost averaging for portfolios that were 40% invested in stocks and 60% in bonds.
60/40 portfolios. Lump sum investing produced 1.8% more wealth each year, on average, than dollar-cost averaging for portfolios that were 60% invested in stocks and 40% in bonds.
All-equity portfolios. Lump sum investing produced 2.2% more wealth each year, on average, than dollar-cost averaging for portfolios that were 100% invested in stocks.
Lump sum investing also outperformed dollar-cost averaging in a majority of market conditions. However, that wasn’t the case during the 25% of years that had the worst returns, Finlay and Zorn found.
But the research didn’t just look backward. The strategists also ran 10,000 simulations to compare projected returns across a variety of market conditions and scenarios in the future. “In line with our findings from the historical analysis, LS in most cases yields greater wealth after one year than (dollar-cost averaging), but LS strategies exhibit more drawdown in the worst market environments, in which the (dollar-cost averaging) strategy has greater wealth after one year,” they wrote.
Lump Sum Investing Without a Windfall
As Finlay and Zorn note, you don’t need a major financial windfall like an inheritance or lottery winnings to reap the benefits of lump sum investing.
Investors may consider front-loading their retirement accounts early in the year, directing as much money as possible into their 401(k)s and IRAs. Keep in mind that this tactic will take some planning, and potentially a sizable cash position to live off early in the year while you front-load your retirement accounts.
“Although this type of strategy means the investor would forgo income for the first few months, our lump-sum strategy research suggests that additional time in the market would lead to a higher retirement account balance on the median, which can be significant if this strategy is used year after year,” Finlay and Zorn wrote.
Bottom Line
Lump sum investing and dollar-cost averaging are two divergent approaches for investing capital. The former calls for an entire sum of money to be invested at once, while the latter spreads those assets across a longer time horizon, reducing both downside risk and upside potential. New research from Vanguard shows how lump sum investing has historically outperformed its more systematic counterpart. However, the researchers found that dollar-cost averaging is still a better option than holding cash.
Tips for Investing
-
If you need help selecting investments or managing your portfolio, consider talking to an expert. Financial advisors don’t just pick investments for you, they can manage your portfolio according to your long-term financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
-
SmartAsset’s asset allocation calculator can help you determine how much of your money you may want to hold in stocks, bonds and cash based on your risk tolerance. The tool also provides a breakdown of different investment options with each asset class.
Photo credit: ©iStock.com/AsiaVision, ©iStock.com/AndreyPopov, ©iStock.com/PeopleImages
The post Should You Invest All at Once or Spread it Out? Here’s What Vanguard Says You Should Consider appeared first on SmartAsset Blog.
Source: finance.yahoo.com