Lump Sums and Dollar Cost Averaging

By: Frank Armstrong, CFP
Congratulations! You won the lottery, inherited some money from a distant relative, sold your company, or rolled your pension into your IRA. You have designed an asset allocation policy that meets your unique needs, and selected your funds. Now it’s time to invest the money. Should Dollar Cost Averaging be part of your strategy?
Probably not! Dollar Cost Averaging doesn’t work very well if you have a lump sum to invest. Here is why.
The market’s upward bias is so strong that the odds of market prices being more favorable during any subsequent period than they are today are tilted against delay. No matter how you measure it, the market has more good periods than bad ones, and the good periods are better than the bad periods are bad. As an example, here is a look at the S&P 500 from 1926 to 2000:

Period Number Periods Number Gains Average Gains** Number Losses Average Losses** Percent # Gains
Month 900 559 4.05 341 -3.90 62
Quarter 300 205 8.27 95 -7.58 68
Year 75 54 22.76 21 -12.17 72
2 Year* 74 62 37.41 12 -20.48 84
3 Year* 73 64 53.27 9 -24.67 88
5 Year* 71 64 90.32 7 -28.84 90

*Overlapping Periods
Percent gains and losses are not annualized
So, if we have a lump sum to invest, the odds strongly favor investing it today. Based on past history, and depending on the period we selected, we would have been right between 62 and 90 percent of the time by committing all the funds immediately rather than waiting until the end of the period for part or all of the funds.
It may feel good (or more prudent) to delay making the commitment with all or part of your lump sum in hopes that tomorrow’s prices will be more attractive. However, it has actually decreased the chances of success. Dollar Cost Averaging with a lump sum is an attempt to “split the baby” that has historically been a losing strategy.
Especially in unsettled times, the temptation to “wait and see what happens” or other excuse to delay making a commitment to the market can be overwhelming. These delaying tactics are thinly disguised market timing strategies.
Of course, you may have the delusional but unshakable conviction that your market timing ability will produce excess returns. This, of course, against the overwhelming evidence that shows otherwise. However, the rest of us should take the course with the highest probability of success: Invest when you have the money!

By | 2018-11-29T16:05:41+00:00 September 19th, 2012|Blog|

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