Choosing dollar-cost averaging or lump-sum investing

Whether you have a little or a lot of money to invest, two primary strategies can help you build wealth: dollar-cost averaging and lump-sum investing. We’ll review their benefits and downsides so you can create a wise investing plan.

What is dollar-cost averaging (DCA)?

Dollar-cost averaging, or DCA, is investing a consistent amount at regular intervals, such as monthly or bi-monthly. If you’re enrolled in a workplace retirement plan, such as a 401(k) or 403(b), and contributing a set amount or percentage of your income, you’re dollar-cost averaging.

Let’s say you invest $500 monthly in an exchange-traded fund (ETF) priced at $10 a share. At today’s price, $500 would buy 50 shares. But if the ETF price increases to $12 the following month, you’d buy 42 shares. If the price falls to $8 the next month, you’ll purchase 63 shares.

Once you choose an investment, its price doesn’t matter because you regularly buy it, whether up or down, with a DCA strategy.

What are the benefits of dollar-cost averaging (DCA)?

Sticking to a DCA strategy over the long term reduces risk by smoothing out how market fluctuations affect your investment portfolio. Plus, it’s easier on your budget if you typically don’t have excess cash to invest a significant amount at once.

Dollar-cost averaging can also make investing a habit and less emotional if you remain focused on how much to invest rather than on the price of an investment from week to week or month to month.

Trying to time the market by buying low or selling high often backfires on investors. That’s because many people become fearful when investment prices drop and they sell, losing money. Or, they get greedy when investment prices rise and buy right before they fall.

So, DCA is an excellent way to continue investing the same amount, regardless of market movements. It helps you avoid the temptation of trying to time the market, which is virtually impossible.

What are the downsides of dollar-cost averaging (DCA)?

The primary downside of a DCA investing strategy is that you could miss a significant increase in an investment’s price compared to making a lump-sum investment. However, as previously mentioned, trying to time the market by waiting for an investment’s price to drop could be futile.

Also, since the financial markets generally increase over the long term, investing a large amount earlier could result in a higher return than smaller amounts over a long period.

In addition, DCA might cause you to pay more trading fees than a lump-sum investment, depending on your investing platform. More fees could reduce your returns over the long term.

DCA doesn’t remove all investing risk; you must still identify suitable investments based on your risk tolerance, time horizon and financial goals.

What are the pros and cons of lump-sum investing?

The opposite of DCA is lump-sum investing, where you invest all your available funds at once. Investing a relatively small amount could be wise, such as contributing to max out an individual retirement account (IRA) for the prior year before your tax-filing deadline. For 2024, you can contribute up to $7,000 or $8,000 if you’re over 50 to an IRA.

However, if you have tens or hundreds of thousands to invest, you’d likely come out ahead using a DCA strategy instead of investing a lump sum. That’s because market swings are challenging to predict, and investing a large amount at the wrong time can be risky. If you make a significant investment that drops in value, you may feel a lot of regret.

Many behavior economists point out that investors react more strongly to market losses than gains. Regularly investing small amounts of money using a DCA strategy may make it psychologically easier to manage a poorly timed investment. Plus, you may feel more confident about investing, knowing that DCA reduces risk and can boost returns over the long run.

To sum up, investing a lump sum could yield higher returns than regularly investing smaller amounts. But if you want to reduce risk, smooth out a volatile market and take control of your investing mindset, DCA may be the best strategy — even if you lose some potential gains.

About the author

Laura Adams is a money expert and spokesperson for Finder. She’s one of the nation’s leading personal finance and business authorities. As an award-winning author and host of the top-rated Money Girl podcast since 2008, millions of readers, listeners and loyal fans benefit from her practical advice. Laura is a trusted source for media and has been featured on most major news outlets, including ABC, Bloomberg, CBS, Consumer Reports, Forbes, Fortune, FOX, Money, MSN, NBC, NPR, NY Times, USA Today, US News, Wall Street Journal, Washington Post and more. She received an MBA from the University of Florida and lives in Vero Beach, Florida. Her mission is to empower consumers to live healthy and rich lives by making the most of what they have, planning for the future and making smart money decisions every day.

This article originally appeared on Finder.com and was syndicated by MediaFeed.org.

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