Dollar-cost averaging vs. lump-sum investing: Pros, cons and when to use each approach
Editorial staff, J.P. Morgan Wealth Management
- Dollar-cost averaging (DCA) is an investment strategy in which you invest the same amount of money in a security at regular intervals.
- Lump-sum investing involves taking the opposite approach: Capital is invested all at once on a single market day.
- More risk-averse investors may prefer DCA because it can smooth out average purchase prices and may help prevent emotional decisions during market swings. Investors who can handle volatility might be better served with a lump-sum approach to maximize their returns when the market runs hot.
- Time spent in the market is more important than timing the market. Both DCA and lump-sum investing are designed to fit into a diversified portfolio and can help prevent the common mistake of buying high and selling low. They can also be used together in a hybrid approach.
Do you have new capital to invest but are unsure of what comes next? Depending on your financial goals, you may choose to invest the money all at once or gradually over time. The approach that works best for you depends on your financial strategy, market outlook and overall risk tolerance.
After all, risk-averse investors might bristle at the notion of investing all at once, particularly during periods of heightened market volatility. They may favor dollar-cost averaging, while those willing to fully utilize their capital for greater potential returns may be better off with a lump-sum approach.
Dollar-cost averaging, explained
Dollar-cost averaging (DCA) is an investment approach in which you divide the money you want to invest into equal parts and then invest it at regular intervals. For example, let’s say you have $12,000 to invest in a particular exchange-traded fund (ETF) and you want to invest it over the course of one year. With DCA, you could invest $1,000 per month so that you have 12 smaller investments.
Investing this way gives you an average price that you paid for the shares. For example, when prices are high, your $1,000 buys fewer shares, but when prices are low, that same $1,000 can help you buy more shares.
Let’s say the share price was $50 for the first six months, which means you were able to buy 120 shares of the ETF (20 shares per month for six months). Then the price dropped to $40 for the next six months, which means you were able to buy 150 shares during that time (25 shares per month for six months). In total, after one year, you invested $12,000 and bought 270 shares of the ETF. The average cost per share that you own is $44.44 – less than what you paid for the shares when they were $50 each.
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Pros and cons of dollar-cost averaging
Just like every investment strategy, there are pros and cons to dollar-cost averaging. On the plus side, it can:
- Ease you into investing: If you are a novice or are worried about market downturns, DCA can offer a calculated path to participating in the market.
- Help prevent you from trying to time the market: Because investments are made automatically regardless of price, you may be less inclined to make emotional decisions based on short-term highs or lows.
- Help you stay committed: DCA locks you into a strategy, helping you stay disciplined during months when the market is underperforming.
- Turn investing into a habit: The longer you stay invested and the more habitual it becomes, the better positioned your portfolio will typically be for long-term growth.
DCA does have some disadvantages, however, including:
- Uninvested funds: You could miss out on higher returns in a rising market since a large portion of your capital could remain uninvested until the next scheduled investment.
- Potentially lower returns: Cash that is sitting idle on the sidelines does not grow; not having it invested could mean you end up earning lower total returns compared to a lump-sum investment.
- More costs: If your brokerage charges a fee for every trade, you will pay a fee every time you invest.
Lump-sum investing, explained
Whether it comes from a job bonus, insurance settlement, tax refund or inheritance, a lump-sum payment can offer an opportunity to make a big splash in the market. Lump-sum investing occurs when you invest that capital all at once, rather than spreading the investment over weeks or months.
Take that same $12,000 mentioned earlier: With lump-sum investing, you could invest $12,000 in a particular stock, fund, bond or other asset immediately, rather than waiting to purchase smaller portions of shares over time.
Pros and cons of lump-sum investing
Lump-sum investing has its pros and cons, too, just like DCA. Some of the positive aspects of lump-sum investing include:
- Maximized time in the market: Historically, the longer your capital is invested, the more opportunity it has to grow and compound over time.
- Immediate earning potential: Your entire investment can begin earning potential interest and dividends right away, rather than waiting for future installments to be deployed.
- Potentially lower fees: If your brokerage charges a fee per trade, a single investment will likely be more cost-effective than paying multiple fees over several months.
And lump-sum investing can have its downsides, too, like:
- Higher immediate risk: If you invest everything at once and the market drops sharply a week later, your entire portfolio will see a much larger decline than if you had spread the investment out.
- Potential for emotional decision-making: It can be psychologically difficult to watch your entire investment lose value at once, which could lead to panic-selling during a market dip.
- Lack of “dry powder”: Since your capital is fully committed from day one, you may not have cash left on the sidelines to take advantage of lower share prices if the market softens.
What to consider when choosing between strategies
When deciding between dollar-cost averaging and lump-sum investing, there are several factors that investors can consider. Let’s walk through them.
Time horizon and objectives
Investors who have a long time horizon may favor lump-sum investing because it means an earlier entrance into the market. This translates to more time for their money to potentially grow and compound. Investors with a shorter time horizon may prefer DCA, which can help reduce timing sensitivity.
Risk tolerance and loss aversion
Investors who have a low risk tolerance may gravitate toward DCA because it can minimize near-term losses. Investors prepared to handle the ebbs and flows of the market may be better served with a lump-sum approach.
Market environment and valuations
Trying to time the market is extremely difficult and shouldn't be a factor when deciding between DCA and lump-sum investing – or any long-term investment strategy. Basing decisions on a single valuation signal, such as a bullish run in the market, isn’t an effective strategy. While markets tend to go up over time, there are short-term corrections and bear markets that DCA and lump-sum investors must be aware of.
Cash type
The source of your funds plays a role in determining which strategy is the better fit. The lump-sum approach may make sense after an investor receives a windfall because it puts that large amount of cash to work immediately. Comparatively, biweekly or monthly transfers from a checking account to a brokerage account might follow a DCA pattern, as you can invest smaller amounts of new income as you earn it throughout the year.
Taxes and accounts
The type of account you are using to invest, along with its potential tax implications, should also be considered when deciding between the two approaches. There are tax-advantaged accounts that you may open and use to invest for retirement and then there are taxable brokerage accounts. Understanding the difference between the two, how taxes and fees work, as well as contribution limits, can help you decide if dollar-cost averaging or lump-sum investing is the better strategy for your goals.
Liquidity and emergency reserves
Regardless of which approach you choose, make sure you’re investing funds that you won’t need for near-term obligations. You don’t want to be in a position where you’re forced to sell an investment prematurely because you need immediate access to cash. Maintaining a separate emergency fund can help ensure your investment strategy has the time it needs to work.
How to implement both dollar-cost averaging and lump-sum investment strategies
Whether you choose DCA or lump-sum investing, implementing your strategy can be relatively straightforward if you take the following steps.
If you choose dollar-cost averaging, start by picking your cadence (the investment interval) and duration. Make sure both make sense for your predefined asset allocation and consider automating the investments. Rebalance your contributions quarterly to ensure your asset allocation remains aligned with your goals over time.
For lump-sum investing, start by deciding what you will invest in and then decide how much you will invest. Consider whether you want to have a small buffer amount of cash on the side – say, 10% or 20% of the capital – for near-term volatility needs.
Investors interested in both methods can consider taking a hybrid approach. You might invest a meaningful portion now and then use DCA for the remaining balance over a set timeline. For example, if you have $12,000, you could invest $6,000 now and then invest $500 per month for the next 12 months. This combined strategy can not only prevent regret but also reduce cash drag which refers to holding too much money in cash so it can’t start working for you.
No matter which plan you choose, you’ll want to implement guardrails, such as committing to a fixed DCA schedule, to help you avoid the temptation of resetting the clock or pausing your plan. Additionally, consider reviewing your investment performance only at predetermined intervals, like every two months or once per quarter. These boundaries can prevent emotional investment decisions and help you stay disciplined, even when the market is volatile.
Common pitfalls to avoid
Both dollar-cost averaging and lump-sum investing have some common pitfalls.
Avoid the following to keep your investment approach on track:
- Pausing DCA based on market moves: Remember, it’s best to avoid trying to time the market.
- Lengthy investment intervals: The longer you wait to invest your money, the more likely you are to create chronic cash drag.
- Ignoring diversification: A diversified portfolio can cushion the blow when parts of the market are underperforming.
- Overlooking transaction costs and tax complexity: Doing so could lead to a sizable tax event or eat away at your returns.
The bottom line
DCA and lump-sum investing are both effective strategies for putting capital to work, and either is far superior to leaving money on the sidelines. When choosing between the two, carefully consider your risk tolerance, time horizon and long-term financial goals. And most importantly, remember that time in the market is significantly more important than trying to time the market. If you’re unsure how to invest your money, a J.P. Morgan financial professional can help you decide which strategy best fits with your long-term goals.
Frequently asked questions about dollar-cost averaging and lump-sum investing
There is not one answer – it will depend on several factors. Lump-sum investing may perform better than DCA because you are in the market longer, so there’s potential for more growth and compounding. But DCA could help your portfolio perform better if you’re able to continuously purchase more shares over time at a lower average price before the price goes up.
It depends on your situation and risk tolerance. Common advice is to use dollar-cost averaging for three to 12 months when you have a windfall of money to invest. But it’s wise to consult a financial professional before getting started to ensure the length of time makes sense for your windfall and investment goals.
Yes, you can use both dollar-cost averaging and lump-sum investing with a hybrid approach. For example, you can invest 70% of your capital as a lump sum and use DCA for the remaining 30%.
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Editorial staff, J.P. Morgan Wealth Management
