For investors who find themselves with large sums of money looking to deploy into the markets, the strategy of how to best do this is often debated. Investors typically choose between the strategies of dollar cost averaging (DCA) or lump sum (LS) investing. Dollar cost averaging or a ‘constant dollar plan’ entails investing the same amount of money in a specified stock or portfolio of stocks over a given time-period, without giving consideration to future price changes. Comparing this to lump-sum investing, where an investor would deploy the full amount of money available to them immediately into a single stock or portfolio of stocks. Deciding between the two strategies is an important and sometimes difficult decision for investors, so to help aid this we will discuss the benefits and risks of each strategy.

First diving into a DCA approach, where cash is invested in equal amounts over a specified time frame or investing a fixed amount from one’s paycheck. An example of what this could look like is if an investor has $100,000 to invest. Instead of putting that whole amount immediately into their portfolio, under a DCA strategy the investor could put $10,000 in at the start of every month for the next ten months, disregarding the price of the desired securities. This approach is ideal for risk averse investors concerned with downside risk and wanting to spread out the timing of investments. If prices drop immediately after the first installment, this approach is beneficial as investors can lower their average cost of shares.

Looking at an LS investment strategy, it is much simpler where the desired full amount of cash is immediately invested. Continuing the previous example of having $100,000 to invest, this would be immediately deployed into the investor’s portfolio/desired securities all in one installment. LS is beneficial for long-term investors who benefit from the potential for higher gains in a market upturn over a DCA investor.

LS investing offers higher upside potential and typically outperforms a DCA investment strategy. Since markets generally display growth in the long-run, investors adopting an LS strategy benefit by injecting their capital in one installment versus incrementally deploying it. Many empirical studies have found this true with LS investing, on average, producing higher annualized returns.

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Both strategies appear effective at deploying investors capital and suit different sets of needs, but investors should also consider the risks associated. For DCA investing, the risk lies in the potentially lower than possible gains. If one is investing during a market up-turn, the DCA approach would produce lower gains than lump-sum investing and even lead to losses. Additionally, DCA investing requires investors to be very disciplined by slowly deploying their capital which can be hard depending on market conditions. Looking at the LS approach, immediate significant losses are definitely a potential factor as investors are exposing themselves more to short-term volatility in the markets. An LS strategy has greater downside risk over the short and long-term compared to DCA.

At the end of the day when an investor is deciding between a DCA or LS approach, they need to first identify their needs and goals. DCA typically underperforms LS investing, but depending on market timing, there is the potential for future upside. Investors should primarily consider 1. Market Timing and 2. Risk Tolerance when considering which strategy to select. If an investor is not concerned with short-term volatility, then an LS strategy is the way to go. Both strategies can be useful and when deciding between the two it is fair for investors deploying large sums of money to be concerned with putting it all into the market at once. There is no sure-fire way of choosing between DCA or LS investing but understanding broader market performance and outlook, along with an individual’s risk profile should help to provide context for investors.

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