We’re often asked: Is it better to invest a big lump sum of money all at once, or to drip-feed your cash into the market?
And there happens to be an easy answer…
Statistically you’re more likely to boost your returns by going all in at once.
A Vanguard paper titled Dollar-cost Averaging Just Means Taking Risk Later found that lump sum investing beat drip-feeding around two-thirds of the time in the UK and US.
This was true across multiple decades and asset allocations – because more often than not equities and bonds trump the returns from cash.
Here’s a snapshot of Vanguard’s findings:
Many other studies have shown the same thing.
The logic is simple. Equities beat cash. Bonds beat cash. (Eventually!)
Equities and bonds are riskier asset classes than cash and investors can expect to be rewarded for bearing that risk. Historically this has come to pass. Over most time periods your investments will therefore beat your bank account.
So the sooner your money is cast into the market, the more likely it is to benefit from the greater potential of equities and bonds to grow.
Yes but, no but…
Wait – what about that one third of the time when drip-feeding wins?
Well, you’ll be glad you chose to drip-feed if the market relentlessly falls over the course of your 12 easy installments. This way every time you buy a punnet of equities, you’re buying them at a cheaper rate than the last time.
You’ll also be glad if, in a parallel universe, you’d have been that shell-shocked investor who threw in your whole £200,000 lot at once and then watched it shrink in a bear market crash like Lake Chad in the face of a population explosion.
So the real question is not about returns. It is could you handle it if luck was against you and your inheritance or bonus or compensation payout – your one life-changing windfall – got vaporised by 50% in a matter of months?
It’s monkey in the mirror time again and drip-feed investing works because it helps prevent that person from going nuts.
I’ve been there
Many first-time investors hang around the edge of the investing pool, unable to dive in.
I know I did.
I couldn’t bear the thought of watching my maiden punt lose – even though my rational brain knew that it didn’t matter because I was committed to investing for the long term.
Every piece of bad news heightened my dithering because, well, if I waited a bit longer then maybe I could buy a little cheaper… but really I just didn’t want to see my money tank.
It was an inauspicious start for a guy who doesn’t believe you can time the markets.
Market timing is not your friend
It’s precisely because we can’t predict the markets that drip-feeding is a useful psychological tool.
We can gather all the opinions we like, check out the P/E ratios and fret about geopolitics, but that kind of rune-reading is little better than superstition. It might salve a troubled mind but it makes no difference to the outcome – which is decided by a game of chance.
Drip-feeding breaks the brain-jam because it promises to cushion risk averse investors against the (less likely) downside.
If the market moves against us early on, then at least we’re not fully exposed, and later drips will buy more shares at a cheaper price.
So drip-feeding (aka pound-cost averaging) is useful, but it’s useful as a psychological crutch, not because it’s likely to boost returns. It isn’t.
If you think drip-feeding is the best way forward for you, there are various methods to try. You might consider investing equal installments over:
- 12 months (never longer according to maths professor Bill Jones)
- Six months
- Four quarters
Or else put in half now and half over the next six months.
Passive investing writer Rick Ferri also has some interesting ideas on drip-feeding techniques, including favouring pound-cost averaging if your cash heap is worth more than 20% of your current wealth.
Your bottom line
Remember, the potential difference in outcomes between lump sum investing and pound-cost averaging is the performance of the market versus cash over your drip-feeding period.
We saw that according to Vanguard’s paper, the lump sum approach wins two times out of three.
But by how much? Well:
In the United States, 12-month dollar cost averaging led to an average ending portfolio value of $2,395,824, while lump sum investing led to an average ending value of $2,450,264, or 2.3% more.
The results were similar in the United Kingdom and Australia: UK investors [who chose lump sum investing] would have ended with 2.2% more and Australian investors with 1.3% more, on average.
Personally, if I doubted my risk tolerance then I’d choose the technique that was more likely to keep me in the game, rather than stretch for 2.2% upside.
That’s because the worst outcome is panicking in the face of a bear market, selling at the bottom, and then being scared off investing for life.
Take it steady,
P.S. Remember this question has nothing to do with pound cost averaging from a regular income like your monthly salary. That’s just an accident of circumstance. Your money arrives as a series of monthly lump sums, and you’ll buy more equities on the dips and less on the highs. But, as market timing is not consistently possible, you’re best off investing it as soon as you can.
- Or dollar-cost averaging as our US chums would have it [↩]