By Francis Bayes, WCI Columnist
When my wife and I married and merged our finances, we transferred the cash in her savings account to each of our Roth IRA accounts. At first, my fear of buying before a stock market crash prevented me from purchasing index-based ETFs with all of our cash, despite the adage that the time in the market beats timing the market. I reallocated the remaining cash to the ETFs only after I realized that I should look forward to better things than the next bear market.
It was my own struggle with lump-sum investing vs. dollar cost averaging.
Since then, we have transferred the maximum contribution amount to each of our Roth IRAs and bought the ETFs with every penny on the first business day of the year, according to our investing policy statement (IPS). This has been possible because, following the aforementioned lump-sum contributions in our first year of marriage, we begin to save for our next-year contributions. We could have bought the ETFs in a taxable account over the course of the year and tax-loss harvested if their values decreased. But we want to ensure that we can contribute the maximum amount on day 1, because once we buy the ETFs in our Roth IRAs, we do not have to worry about them for another 30 years. Until we buy them again on the following year’s first business day, we do not even need to check their prices.
Yes, I did this in January 2022 before the market tanked. And no, I don't regret it.
Because I struggled with my first attempt at lump-sum investing, I understand the dilemma that people face when they ask about “lump-sum investing vs. dollar-cost averaging (DCA).” On the WCI Forum and Reddit, the question often starts as, “I received $XX,XXX as a gift/inheritance/bonus…” (the answer is that you should fund other things beforehand.) Although numerous blogs and podcasts have addressed this question, new threads continue to appear. Crowdsourcing the answer under anonymity is an excellent way to receive free advice on personal circumstances that one cannot share with coworkers or even friends. Yet, among “financially correct” comments that have been repeated in similar threads, the original poster may be searching for one that validates their current behavior.
As humans, we tend to either think that we can beat the odds, or we fail to comprehend the odds. It fuels the gambling industry and lotteries. It prevents people from flying on commercial airplanes while they drive their cars over the speed limit. Likewise, many investors (including myself!) want to defy the experts who claim that lump-sum investing outperforms DCA, with the latter defined as “investing all of your available money over time.” Critical thinking has no chance. We cannot resist thinking that we are not like an average investor.
But those of us who have committed to lump-sum investing must keep chipping away at this wall of fear, inertia, and/or overconfidence. One may be reluctant to reallocate their cash after completing a Backdoor Roth IRA conversion in January or determining how much they can contribute to their solo 401(k) in April. In this column, let's discuss five things that we can tell ourselves when we struggle to choose lump-sum investing over DCA.
#1 We Are Not Investors
We are not investors. We are a doctor, a future doctor, or another non-financial professional. We happen to have enough interest in personal finance to manage our own money. As Cullen Roche argues, we should think that we are reallocating our cash to buy assets rather than “investing” it.
Wherever we are, most investing talk is junk. Others' words will go in one ear and out the other because we do not think of ourselves as an investor. We are going to overhear our coworkers talk about stocks and brag about how they are outperforming the market. Good for them. They are going to complain about inflation and taxes. So be it. Our hospital gym is going to have CNBC on the TV, quite possibly Jim Cramer. May I change the channel? If we think that we are an investor, we will be an average investor who underperforms the market because we will let their words make a pitstop between our ears.
The irony is that I am writing for The White Coat “Investor.” But if you look at his IPS, Dr. Jim Dahle is more of a bandwagoner than a trailblazer when it comes to buying the stock market. Why? Because the only way to be better than the average investor is to allow other investors to give you the average return of the stock market via a broad-market index fund. If we save at least 20% of our gross income and take appropriate risk, we should have no trouble reaching financial independence with the historical average return of the stock market. The sooner we reallocate our cash and hitch a ride (and NOT think we are investing it), the less likely we are to be left behind.
#2 We Can Be the Owner of Our Money (and Not the Other Way Around)
We may be a cog in the wheel when we’re trainees, but we do not have to be an employee at the side job of managing our money. When we have money in our checking account, we will be tempted to work with the money. But that is not the mindset of an owner who does not have to work every day. We can be the owner that hires our money to work at the stock market all the time (without commuting back and forth to our checking account or reporting to us daily). Be the owner/employer that we want in our day job by not micromanaging our money.
Our day job will also be a greater source of income than our side job until we reach a “break-even point.” As trainees, we should focus on our day job with the goal of (1) becoming the best physician that we can be and (2) educating ourselves on personal finance, and if applicable, the business side of medicine. As long as we maintain minimum supervision (i.e., sending our money to their job as soon as possible), our side job will be flourishing by the time we graduate from our training 4-8 years later.
#3 We Can Maximize Our Hourly Income
After complaining about how you make less than minimum wage during residency, don't you want to maximize the hourly income of your side job? If we spent one hour on the first business day of 2021 (1) transferring the maximum contribution amount to our IRA account and (2) buying VTI/VTSAX (or FSKAX) in lump sum, we made at least $90 in one hour ($6,000 x 1.51% annual dividend yield). Many of us would take any job that advertises pay greater than $70-$90/hour for clicking some buttons.
#4 We Only Live Once
The idea that time is the most valuable resource that money can buy is not an original idea in personal finance. If you already worked on New Year’s Eve or New Year’s Day, you should have had enough reminders that life is short by the time the stock market opens on the first business day. How much do you value one hour of rest? How about one hour of family time? If we automate our investments throughout the year and we finish our manual contributions on the first business day, then we free ourselves from time spent on: (1) thinking about investments, (2) thinking about investing, (3) actually investing, (4) second-guessing ourselves after investing, and (5) thinking about investing better the next time. Such thoughts are not worth our time.
#5 We Won’t Notice the Difference Later
Writers like Nick Maggiulli have shown that buying the dip does not work in the long-term, but given our recency bias, I will use numbers from the first half of 2022 to hammer home a point. What would be the impact of hypothetical DCA strategies on our journey to financial independence (e.g., shorten it by a few years)? Let’s compare the performance of the following strategies in 2022 (Table 1):
- Strategy #1: buy $6,000 VFIAX on day 1 (“lump-sum”)
- Strategy #2: buy $3,000 VFIAX on day 1 and DCA the rest at the end of each month (“half-and-half”)
- Strategy #3: buy $500 VFIAX at the end of each month (“DCA”)
- Strategy #4: buy $500 VFIAX on the day the price bottoms for the month (“Perfect DCA”)
With the Perfect DCA strategy, our unrealized loss would be $1,000 less than that of the lump-sum strategy (-$1,264.17 vs. -$207.31), and we would still have $3,000 to “buy the dip.” Successfully buying the dip every month is almost impossible, but let us entertain the idea. On July 1, we decide that the stock market has fallen enough and that we will buy lump sum. What would be the difference in our portfolio in 2052, assuming 10.5% annualized return? About $21,000. Or about an attending physician’s monthly (or even less than semi-monthly) paycheck.
This comparison also assumes that we can predict whether the new year is going to be like 2021 (when the S&P 500 returned 28.41% including reinvested dividends) or the first half of 2022. We will have more years that are not like 2022 during our working years. The DCA strategies above are neither worthwhile nor sustainable.
I hope this column encourages more readers to reallocate their cash on Monday, January 2, 2023; or if they have excess cash now, as soon as possible. After you buy index funds in lump sum today, their prices might plunge tomorrow. But if you have the right identity and mindset, you will not check the prices tomorrow. The next time you try to buy index funds in lump sum, you will not have any regrets. You might even be pleasantly surprised.
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How do you decide between lump-sum investing and dollar cost averaging? What's your preference? Why do you feel that's the best move? Comment below!
There us no difference between lump sum and DCA investing on average. Some years it might be better others not so much but on average it should not matter. The difference is that DCA should have a smaller range of returns- the standard deviation.
You’re right it doesn’t matter all that much in the long run. On average, lump summing does come out ahead though historically.
As this is a financial post, one must be mindful of potential divorce. The wife’s savings were her property before marriage, in case of divorce she has very likely lost those assets placed in spousal IRA and their long term growth. Sadly, with the divorce rate high it must be considered in any investments.
1. For us, merging our finances was the easiest way to assess our financial health and remove any unnecessary friction.
2. I also married into her loans (I don’t have any), so I went from broke to worse than broke.
3. Divorce rate among college-educated Americans has been stable in the 20s, so divorce rate isn’t as high as one might think. But of course, everyone’s “risk tolerance” is different.
Good article. Nice to see more DCA testing taking place. But there are several dimensions of trading/investing that this article doesn’t address or consider in it’s analysis. There are also several different ways to use DCA strategies. DCA vs. Lump Sum is kind of a one dimensional way of looking at investing methods. Consider >>>
1. DCA’s FRACTION CAPITAL DEPLOYMENT PROBLEM. One of the biggest disadvantages of DCA investing/trading is that most people’s capital is limited! In DCA investing, it capital being deployed in fractions. Because you always have to keep some % of your total available capital “on reserve” for the DCA safety trades. This means that, even when you have gains or closed deals at profit, only a small % of your total available capital has been deployed. Full power DCA trading/investing is 100% dependent upon the price falling, in order to deploy all of the available capital. If all of the capital is never deployed, then even a substantial gain in your short, or long term investments will be fractional. This is the main reason that DCA investing usually doesn’t outperform lump-sum. Because lump-sum deploys all available capital = Any gains are on 100% of the total available capital. So that both the ROI, and IRR are greater, per deal/investment period or action. DCA methods can be very helpful to close individual deals, at accelerated rates = higher IRR. But the capital balancing of your overall portfolio will be very weak. Additionally. >>>
2. THE PRICE STILL NEEDS TO RISE. Because DCA investing still requires that the price rise, in order to gain profit/close deals. DCA-ing a losing asset won’t help you gain profit. At all. — As Peter Lynch reminds us “How far down can the price fall? Even on “good companies? The answer is zero $!” Yikes. Unless you have unlimited capital to keep DCA funds adding (like a fund that raises new capital regularly), then you will eventually run out of funds to DCA with, and your capital will all be deployed at the higher prices, with very marginal DCA benefit. Just like the author’s experiments. Many veteran traders have stories of assets that lose unbelievable value, due to circumstances that the trader/investor cannot foresee or control, and that technical analysis cannot prepare or solve for. DCA trading doesn’t help with this at all.
3. FULL TIME FOCUS OR SIDE HUSTLE. If you can’t act/trade like the pros, then don’t try to fake it. It comes down to whether or not you have the time, attention span, and skill to be an “active trader”. Or, if you need to take a more hands off approach. I would argue that the biggest difference in ROI and IRR between different investors and traders’ success is how well they play the odds, and how often. Proof > Look at any of the top performing funds. They may DCA, sometimes. But mainly they all lump sum, raise capital to lump sum some more, and then…. Stop loss/”un-wind” positions when market, economic, and asset/company conditions change for the worse. Example. Cathy Wood “un-wound” Tesla and other heavy positions, even as she was lauding them as the best investments in tech’s future over the next 5 to 10 years (Jim Cramer said it was “like she started trading yesterday”. Super rude.) Why would Kathy sell, Jim? Because she can clearly see the edge of the cliff in January, February and March 2022. Why should Kathy keep heavy long, HODL positions only to have t o endure a 40%, 50%, or an 80%! hit on some of the best companies? Kathy simply un-wound, at all time price highs, and during obvious gloom and gloom Global times. Now it’s time to buy back at substantially lower prices. The power of preventative, and reactive stop loos is absolutely immense. >>>
4. STOP LOSS. AS NEEDED. I am a fan of lump sum investing/trading. BUT. Only with a stop loss plan. No one has a crystal ball. And I’m not waiting 10 years, or 30 years to maybe cash in on speculative market investments. All that is required to lock in annual and even shorter term profits is to buy statistical dips, and sell statistical highs. The ratio of winning trades, whether 1 week, 1 month,1 year or 5 years will FAR surpass un-managed ,or unmodified lump sum trades. The un-managed lump sum investment will fall of the edge of the world (like this year), and may take many months, or even years to recover. Simply stop-lossing allows you to lock in any achieved gains, and, re-invest at much more favorable prices (like now). If you don’t have the skill or time to figure out what this means for the assets that you are interested in investing in, then find a broker or fund that can help do it for you. It’s that simple.
5. OUTPERFORM – TIMING IS EVERYTHING. Opening lump sum deals at statistically logical prices is vastly superior to randomly timed lump sum investing, or long period reactive DCA safety trading. When you see prices, across multiple asset classes at “all time highs”, be cautious! Ride the wave uP, but, be prepared to stop loss sooner than later. Because any severe change in political landscapes, markets or economic conditions is likely to crush all time high prices, in any asset class. It’s not rocket science. Timing Example; When the whole World is facing hyper inflation, and is on the verge of World War 3, you may wanna sell take profit/stop loss. 🙂 Conversely, when inflation and interest rates finally start to taper, and Russia pulls out of Ukraine, be prepared for an extended rally of a lifetime. Go lump sum heavy and big on your favorite assets. Because it’s statistically very likely that it will be a good time to buy. Actively managed positions, and TIMING is the key to higher than average returns. Not “insider info” or “bots”, DCA, or lump sum HODL-ing.
6. MIND YOUR ROI AND IRR. It doesn’t matter if you trade into and out of an asset 10 times per day, or only once each year, or every five years. All that matters is buy/sell timing…. If you have a great ROI, but it took too long to earn, then the IRR will be diminished, and your investment quality will be severely substandard. Even worse, if it takes you 5 years, 10 years, or 30 years to find out what the IRR or ROI even is, then you may end up waiting all that time, only to find an empty, or weak ROI and IRR. Try unwinding a 30 year investment that suddenly, at the last minute near to your planned maturity, tanks. It happens. 🙁 Managed funds help smooth this out, but even they can’t solve for hyper inflation’s effect on ROI. Your 10% fund return over the last year is actually only worth only about 3% today, due to the affects of inflation. Since $1 of value 12 months ago only buys you about $0.93 of most consumer goods today, or less. Yikes. The ROI, and IRR were obliterated by inflation, and mass market sell-offs that we have been experiencing for months.
Thanks for reading. Post criticism and comments. Happy investing!
Sounds like you do a lot of trading. In general, that doesn’t work very well long term, especially in a taxable account. Be sure you’re tracking your returns and comparing them to a long-term buy and hold approach (be sure to account for taxes and the value of your time) to make sure you’re actually coming out ahead.
Hey Frances, great article I love the frame where “we are not investors” which helps us behaviorally lump sum and in the end makes us better investors!
Also love how you’ve used YOLO to enable lump sum investing instead of the usual use of YOLO to justify spending. Brilliant!
Fascinating and enlightening piece! 🤔 you’ve got me rethinking my DCA strategy in favor of Lump sum, especially with my year-end bonus coming up. I appreciate lifting pressure from considering ourselves as investors first, physicians second. Thank you 🙏🏽