Upbeat music plays throughout.
Narrator: Say you've got a chunk of money you want to invest. Is it better to put it to work in the market all at once or to buy gradually over time? I'm Cameron May, and this is Comment below.
Brandon Low commented, "Great content." Hey, thanks Brandon. "I hope you can do a video comparing dollar-cost averaging and lump-sum investing. Which are better performers in the long run?"
Well, Brandon, the debate between dollar-cost averaging and lump-sum investing is a long one. Let's look at each side.
Dollar-cost averaging is continuously investing the same amount of money in a security over time, regardless of fluctuating prices, rather than the entire amount all at once.
For example, if you wanted to invest $1,000 in shares of stock that's currently trading at $50 per share, you could break it up in to five increments of $200 to purchase shares at regular intervals.
Let's say you were able to purchase shares at $50, $48, $47, $51, and $52 over a period of time. Your average price per share would be $49.60.
There are a couple of benefits to this. First, you have a psychological benefit of not risking the entire amount immediately and having the anxiety associated with the stock falling.
Second, if the stock falls after your first purchase, you're only losing on a small amount, and the pain is less.
Third, as you saw with the example, buying over time could bring down your average cost per share if the stock drops.
However, there are risks. If the stock price rises over time, you're buying at a higher price, which will increase your average price per share. Not to mention missing out on possible gains if you'd invested the full amount at the beginning. Of course, if the stock price falls over time, you'll keep buying at lower prices, but there's no guarantee the stock will go back up.
Also, investors who practice frequent dollar-cost averaging may generate additional trading costs, commissions, and other transaction costs that outweigh any cost benefit.
Another approach is lump-sum investing, which is the immediate investment into a security using all available funds. So, going back to the earlier example, it'd mean investing the full $1,000 at once for $50 per share.
If the stock rises, you're all in, and you get all the benefits. If the stock falls, you're all in, and you get all the losses.
Now back to the question earlier: Which are better performers in the long run?
Is it lump-sum investing or dollar-cost averaging?
Let's look at an example.
Imagine there were two long-term investors who received $2,000 at the beginning of each year from 2001 to 2020 and invested in a hypothetical portfolio that tracked the S&P 500® index.
One is a lump-sum investor who put the $2,000 in the market right away on the first trading day of each year.
And one used a dollar-cost averaging strategy and divided the money into 12 equal portions to invest at the beginning of each month.
After 20 years of investing, which investor stood on top?
Animation: Chart compares the lump-sum investor who made $135,471 versus the dollar-cost averaging investor who made $134,856 from 2001 to 2020.
On-screen text: Disclosure: Source: Schwab Center for Financial Research. Past performance is no guarantee of future results.1
Narrator: In this example, the lump-sum investor who invested the money immediately was the winner, but not by much—only $615. The dollar-cost averaging investor was right behind.
In fact, Schwab analyzed 76 rolling 20-year periods dating back to 1926—for example, 1926 to 1945, 1927 to 1946, and so on. In 66 of the 76 periods, the results were the same.
The takeaway here is don't procrastinate. Realistically, the best action long-term investors can take, based on our analysis, is to determine how much exposure to the stock market is appropriate for their goals and risk tolerance and then consider investing as soon as possible, regardless of the current level of the stock market.
However, there still can be a place for dollar-cost averaging. It could help investors who like the discipline of investing small amounts at regular intervals, especially if they think they might regret a large investment if it sees a short-term drop.
Dollar-cost averaging allows you to manage some risk on entry, but lump-sum investing, plus portfolio management strategies like rebalancing, may provide the best of both worlds: putting money to work more quickly along with risk management throughout the lifetime of your investments. Regardless of which approach you choose, be aware of your risk tolerance and be intentional about your strategy for managing risk.
On-screen text: [Schwab logo] Own your tomorrow®
