Lump Sum Investing vs. Dollar-Cost Averaging: Which Is Better for Retirement?

The pros and cons

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Jan 29, 2018
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When it comes to investing for retirement and funding an IRA or 401(k), a lot of people struggle with the best course of action. Is it better to invest a bunch of money once or twice per year, or gradually invest small sums of money month after month?

What is dollar cost averaging?

As Investopedia’s James E. McWhinney explains, “Dollar-cost averaging (DCA) is a wealth-building strategy that involves investing a fixed amount of money at regular intervals over a long period. This type of systematic investment program is familiar to many investors, as they practice it with their 401(k) and 403(b) retirement plans.”

Most people are familiar with dollar-cost averaging. It’s what happens when you instruct your employer to take out a fixed amount each month, say $500, and put it in your retirement account. You’re not trying to time the market and hit it when it dips – you’re simply making regular installments with the belief that everything will average out over time.

Dollar-cost averaging is a safe play. You’re never going to get burned taking this approach and you greatly minimize the risk of a huge investment. It’s especially ideal in a volatile financial landscape or bear market.

However, you’re rarely going to beat the market by a significant margin. You’re essentially accepting stable returns over everything else.

What is lump sum investing?

The second popular investing option is known as lump sum investing. As the name suggests, lump sum investing is where you invest a bunch of money at once, as opposed to spreading it out over multiple installments.

Let’s say, for example, that you invest $5,500 each year into a Roth IRA. Instead of spreading it out into 12 equal installments of roughly $458, you would invest all $5,500 at the beginning of the year. The logic is that the stock market has a history of improving over time, so getting in earlier gives you a longer period of time to earn a positive return.

“Generally speaking, most investors go with dollar cost averaging out of necessity,” Allgen Financial explains. “They simply don’t have a bunch of money sitting around that they can plug into a retirement account. But if you are one of the lucky few who has cash parked somewhere, there’s a case to be made for lump sum investing.”

If you take the time to study the research and data – such as this recent report from Vanguard – most agree that, over a large timetable, lump sum investing is always better. However, it’s notably uncertain when you’re only putting your money into an account for a few years at time. There’s always the risk that you could invest when the market is peaking and then spend years trying to get even again.

There is no secret weapon

When you boil it down and really compare dollar-cost averaging and lump sum investing, it becomes evident that investing is a highly personal decision that has a lot to do with chance. Considering the market that we’re currently in – one that keeps going up and up – there’s nothing wrong with dollar-cost averaging. You just need to make sure you don’t stretch things out for too long.

There is no secret weapon. Just start investing and remember that time is your friend.

Disclosure: I do not own any of the stocks mentioned in this article.