Before you invest a lump sum, READ THIS
Do you have a chunk of money you’d like to invest? Maybe you got a bonus at work, a tax refund, or an unexpected birthday check from Grandma. You have two options: invest the entire cash stash (“lump sum”) or do dollar cost averaging (DCA). Each method has pros and cons.
Note: whether you choose lump sum or DCA investing, putting your money into various types of investments, also known as “diversification,” is still important.
Option 1: Invest a lump sum
Investing a lump sum means investing the entire amount at one time.Pros of lump sum
- Potentially greater chance of getting higher gains: investing more and sooner may increase your chances of getting higher returns in the long run, according to analysts at Charles Schwab and Morgan Stanley. Both firms found that a hypothetical person who invested a lump sum would have ended up with more money than someone who had done DCA over the same time period, all other factors being equal. Since, in the past, the overall market’s value has tended to increase in the long term, the earlier you invest the more time you have for your investment to grow. Note: these studies are based on statistical analyses of historical information. They do not predict future results for any specific person. The difference in returns between lump sum and DCA strategies are uncertain.
- Less work: once you’ve invested, you can move on. You don’t have to repeat the task for multiple installments over time.
- More potential for feeling upset: if risk makes you nervous, lump sum investing might not suit you as well as DCA. While investing is based on the idea that, over time, the value of your investment will likely rise, the increase does not happen in a straight line. On any given day between when you invest and when you are ready to cash in, there’s always a chance that the value of your investment may dip. If the price falls soon after you invest your loot all at once, you might not feel great.
- More potential for making a rash decision: a quick price decrease could make you panic. Then, you might react in a way that hurts your finances in the long run. For example, you might respond by pulling out your investment at that low point, or the experience might cause you to avoid investing in the future. Lump sum investing may benefit people who have the capacity to let their investment sit untouched. Take care, because some people don’t know how they’ll respond to market decline until they experience it.
Option 2: Do dollar cost averaging
With DCA, instead of investing your entire cash stash (“lump sum”) at one time, you divide it into smaller amounts and invest them over time. By buying assets (investing) over multiple dates, you pay different prices for the investments, depending on the market prices on those dates. So, the price you pay will be across a range. In the end, the average price you pay is somewhere between the high and low points in that range. Then, when you sell the investments – for example, when you’re in retirement, you might begin selling the assets to pay your bills – hopefully the price will have increased from when you bought them. You get to use the difference in price (called a capital gain) to enjoy your third act.Pros of DCA
- Less extreme mood swings: DCA may help steady your emotions. If you invest a fraction of your total amount one day, and the price of the investment falls soon after, then you might not feel as badly as if you had invested it all.
- Support sticking to a long-term plan: knowing you’ll have time for the price to increase before you invest your next installment might help you stick to your long-term investment plan (instead of making a rash move with your money).
- More work: instead of investing once and not looking back, you have to put in more work. For example, if you decide to spread the amount throughout a year, you may need to invest 12 times (once per month).
- Risk you’ll forget or get distracted: DCA comes with the risk that you’ll forget to invest. Or you might be tempted to make an impulse buy instead. These challenges could make it harder for you to reach your long-term financial goals.
Make a choice and go for it
Investment decisions can feel complex and overwhelming. If choosing between lump sum investing and dollar cost averaging feels challenging, please know that many people use either method to help them increase financial wellbeing. If you are ready to invest, then the least beneficial choice would be to hold back because you are not sure what the best next step is. Often, a clear “best” answer does not exist. So, consider the options and your situation, and make a move!Hungry for more knowledge? Read on to learn how having a long-term investment strategy may help you through a recession.
If you don’t have a retirement investing account, or if your employer contracts with a different retirement plan provider, we’d love to show you Just Futures’ services! Contact us: info@justfutures.com.
~Lisa, Manager of Coalitions and Worker Power