Lump Sum vs Dollar Cost Averaging
I've just sold an investment property so have received a lump sum of cash. Should such a large amount be invested all at once or drip-fed into the markets using dollar-cost averaging? - Submitted by Catherine
First, congratulations on the sale of your property, I assume you have made a good return on this so well done.
Normally when we discuss dollar cost averaging versus lump sum investing it comes down to a few factors as both strategies have pros and cons.
Lump sum investing will mean your investment funds are immediately working for you as they are in the market. And, being in the market will, overtime, outperform being out of the market. Secondly your brokerage will be, on average, cost efficient as the investment is all done in one shot at an average percentage that will be lower than say a fixed amount of brokerage.
If we also look at the current market situation that has been created from COVID-19 the ASX 200 for example is some 1200 points from its high so it could be argued that there is a solid discount in the market.
However, under normal circumstances lump sum investing can cause investors to try and 'time' the market. It also leads people to buy when news is good, which is normally when investments are expensive and sell when news is bad, which is normally when investments are cheap (like right now).
This why dollar cost averaging can make things simple as it removes your desire to ‘time the market’ and also means you buy more when things are cheap and less when its expensive.
the strategy works as follows –
First, you make the call on how often you want to invest; it could be monthly, every six months, or yearly – it really doesn’t, what does matter is that you stick to this strategy a every time point.
Second is the amount.
For arguments sake let’s say you are going to invest $5000 and you’re going to do this every month.
So, lets use 2020 as the example of how dollar cost averaging would have worked for you. In February your $5,000 would have brought investment X at $1 therefore you would have brought 5,000 parcels of X (I have ignored brokerage).
In March when the market had fallen 25% investment X was now worth $0.75 so a $5,000 investment in investment X at $0.75 would have netted you 6,667 (rounded up and ignoring brokerage again) parcels of X.
At the end of March, you would have had 11,667 parcels of X at an average price of $0.857. If you kept doing this strategy in April, May and now June that average price will have continued to come down and your February purchase will have been diluted to a much better price as your purchases from March through June would have been bigger and cheaper. That how dollar cost averaging works.
Now, how you structure your investment strategy from your investment property lump sum is up to you. You could do half as a lump sum now the remainder as a dollar cost average strategy or other variations of this idea. Again, there isn’t a right or wrong answer here its more around working out what will be the best option for you but once you have worked that out – stick to this strategy as best you can.
Hope this helps