Many investors wonder if dollar cost averaging or lump-sum investing is a better strategy. The answer often depends on the investor’s experience, risk tolerance, and investment horizon.
Dollar Cost Averaging
Dollar cost averaging is the process of contributing a predetermined amount on a regular basis to an investment rather than contributing sporadically or in one large lump sum. This could be weekly, bi-weekly, monthly, or any other regular interval.
Dollar cost averaging may help reduce the risk of timing the market. Regularly investing a predetermined amount spreads out the average cost per unit purchased over time, helping control the effect of market volatility. By spreading out purchases over time, an investor’s chances of buying when the price is too high may be reduced.
This method can be made easy with regular automatic contributions. Smaller, regular contributions may be easier for an investor to keep up with, rather than setting aside funds to make a lump-sum contribution at a future date. Additionally, regular contributions will begin earning returns immediately.
All in all, dollar cost averaging may result in a lower average cost and higher returns over time. However, there may be cases where lump sum investing makes more sense for an investor.
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Lump-Sum Investing
Lump sum investing is the process of contributing a large portion of investable cash all at once. The lump sum can be any large amount of investable cash, possibly a year-end bonus or inheritance, among other possible life events.
Lump-sum investing will not help reduce the risk of timing the market incorrectly like dollar cost averaging can. However, lump sum investing may be advantageous for investors with long investment horizons who would like to put their money to work as soon as possible. By investing a large amount all at once, the investor has more money-earning returns sooner than if they had used a dollar cost averaging method.
Markets generally rise over time, so an investor with a long-term horizon may be able to ignore any near-term volatility or declines in the investment after making a lump-sum investment.
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