Lump sum investing vs dollar cost averaging: Finding the right mix

For those who have diligently saved their money with the goal of investing in a diversified portfolio, deciding how to best allocate your hard-earned savings can be tricky. Two popular strategies emerge: lump sum investing and dollar cost averaging (DCA). Let’s break down each approach and explore which might suit you best.

Lump sum investing: Capturing the upside

Lump sum investing is where you invest all or a large portion of your capital upfront. Some studies suggest this approach has historically yielded higher returns over the long term. The logic is simple: your money starts working for you sooner, benefiting from the tendency for markets to trend upwards over time.

However, this strategy hinges on the assumption that the market continues to trend upwards and assumes that investors don’t react negatively and sell assets during a downturn. But, we know that people feel the pain of loss in a meaningful way, particularly if the loss comes at the start of an investment portfolio building journey. This strong emotional reaction can often lead to poor decision making like selling down high quality assets at the wrong time. 

DCA: Spreading the risk and calming your nerves

DCA takes a more conservative route. You invest a fixed amount at regular intervals, say monthly or quarterly. This approach averages out your purchase price, potentially softening the blow of market downturns. DCA fosters a sense of discipline and removes the emotional element – you’re not trying to “time the market” by picking a perfect entry point.

Finding the sweet spot: A hybrid approach

So, which strategy should you choose? The truth is, it depends on your risk tolerance, goals and market conditions. Here’s an approach many investors find appealing:

1. Partial lump sum: Allocate a portion of your capital, say 25-50%, for a lump sum investment. This captures some of that potential upside early on should markets rise in the short term.
2. DCA the rest: Invest the remaining capital consistently through DCA over a defined period, say 6 to 18 months. This helps manage the risk of investing a large sum right before a downturn and fosters a buy-low mentality as you’ll be acquiring more shares when the market dips.

The bottom line

There’s no one-size-fits-all answer when it comes to lump sum investing versus DCA. Consider your risk tolerance, investment goals, and the emotional aspects of investing. By potentially combining the two strategies, you can craft a plan that optimises your returns while keeping you comfortable on the investment journey.

Speak to a financial adviser

For personalised guidance, chat with a qualified financial adviser. They’ll help you develop an investment strategy that aligns with your unique financial goals and risk profile.