What is dollar-cost averaging and how does it work?
It works this way. Say you invest $100 every month. In an up market, your $100 will buy fewer units, but in a down market, your money will buy more. Over time, investing this way can lower your average cost per unit — compared to what you’d have paid if you'd bought all your units at the same time when they were more expensive than the average.
Dollar-cost averaging benefits
Treats investing like a habit – When you handle investing like it’s a bill payment (through automatic payroll deduction or not) you won’t spend the money on something else or forget to invest.
Removes emotion from investing – Because you invest smaller amounts over time, you’ll be less likely to get upset if your investment falls in value.
Prevents poor market timing – Market timing is trying to buy your investment at its bottom price and sell at its top price. Dollar-cost averaging helps ensure your money is invested when the market surges.
Ideal for beginning investors – It lets you invest small amounts, avoid hype and inaccurate ideas and data about the markets, and keep your focus on your investing plan and long-term investment goals.
What is lump-sum investing?
Very simply, it’s investing a larger sum of money, all at once, rather than spreading it out over a longer time.
Lump-sum investing benefits
More money invested longer – When you invest in a lump sum, all the money you have to invest is in the market at once, so it can all potentially rise in value.
Keeps a long-term vision – Lump-sum investing is best for “set it and forget it” type people. They’re investing for the long haul and are okay with seeing a loss on their investments knowing they could be up in 20 years.
Which strategy gives the best results?
According to Advisor.caOpens a new website in a new window, dollar-cost averaging provides poorer results than lump-sum investing about 2/3 of the time, to the tune of .38% per year over 10 years.
Which strategy is right for you?
Dollar-cost averaging may be for you if you:
- Want to take emotion out of investing and avoid market timing
- Wish to limit your investment risk over time
- Are looking to lower the average price per share/unit of your investment
- Are an inexperienced investor
Lump-sum investing may be for you if you:
- Can take the emotion out of making investment decisions
- Have a higher investment
- Desire the highest potential investment returns
- Are a more experienced investor