Investing-What's the best way to put money into the market?

 

Which investing method is better?

According to a Vanguard study comparing lump sum versus dollar cost averaging, the former resulted in higher overall return 66% of the time.[1]  Reason being, the sooner you put your money to work, the sooner you benefit via dividends and potentially price appreciation.  Additionally, in terms of historical trends, the stock market typically goes up over time.  (See Exhibit 1.)

 

Exhibit 1: Dow Jones – DJIA – 100 Year Historical Chart (2021)

 

 

Source: Dow Jones – DJIA – 100 Year Historical Chart, October 2021.  

 

Unfortunately, as with most things in life, things are not as simple as they seem.  Successful investing requires finding a delicate balance between opposites, foremost being: 

·      Profitability: Risk vs return 

·      Psychology: Risk tolerant vs risk averse 

·     Timing: Now vs later vs much later

 

In terms of profitability over the long-term (10 years-plus investment horizon), lump sum is the better option.  However, there are a few caveats to keep in mind.  First, while the market trends up over time, an equally prevalent trend is that bull markets are always followed by bear markets, some of which last more than a decade.  For example, it took the market 25 years to recoup losses from the Great Depression.  (See Exhibit 2.)  Second, not everyone has a 100-year investment horizon.  The average American worker has a 42-year career (at most) wherein they can earn, save and invest.[2]  

 

Exhibit 2:  Dow’s Bull and Bear Markets (1897 – 2020) 

 

 

 

 Source:  Guggenheim Investments using data from dowjones.com. (2020)

 

 

In terms of psychology, different investors have different risk tolerance level.  Moreover, it’s typically very difficult to gauge individuals’ risk tolerance level with a high degree of accuracy.  Unfortunately, most people’s real risk tolerance level is revealed during a market crash.  And, if they’ve just invested a lump sum beforehand, it may be harder to hold when faced with a sharply declining portfolio.    

 

While lump sum investing is an offensive strategy that seeks to take advantage of the market’s predominantly upward trend over (a long) time, dollar cost averaging is a defensive (investing) strategy where one assumes that it’s impossible to predict the market’s direction in the short- and mid-term.  As is, it’s (psychologically) safer to invest in smaller increments over a certain period of time.  This way, you’re able to buy some shares high, some low, some in the middle.  

 

Conclusion  

When it comes to investing, the best strategy is to buy and hold and hold and hold… It’s in the holding that investors make their money as that facilitates compounding – “the eighth wonder of the world” (Albert Einstein). To be able to hold investments successfully over a long period of time is a balancing act that requires taking into account a host of competing factors: profitability; psychology; time.  While lump sum investing may be statistical more profitable over time, dollar cost averaging may be psychological safer over time and, thus, may help you hold onto an investment longer, resulting (potentially) in greater profitability.  

 

Ultimately, when it comes to successful investing, the real deciding factor is you, the investor. Although it’s important to be aware of the pros and cons of different approaches, it’s probably more important to know yourself.  So, rather than ask yourself if lump sum investing or dollar cost averaging is better, ask yourself which method will allow you to hold your investments the longest over time.  Truth is, at the end of the day, it’s not the buying (and selling) that’s most difficult, but rather the holding.