If you receive an inheritance, sell a business, receive a large bonus, or win the lottery, you may have a large chunk of change you want to invest in the stock market. There can be risks to investing that money all at once; what if the market drops by 30% the year after you invest?
To reduce the risk of investing a large sum of money at the wrong time, you can dollar cost average (DCA) your money into the market. This means investing smaller amounts over a period of around 8 to 12 months. Here’s the difference between lump sum investing and dollar cost averaging and how to choose which strategy to utilize.
Lump Sum Investing
Don’t sweat the small stuff! When the cash to invest is just a small percentage of your investable net worth, typically less than 10%, you may consider getting that money to work as quickly as possible and investing it all at once.
Dollar Cost Averaging
When the cash to invest gets to a larger percentage of your investable net worth, then it makes more sense to be more methodical about working it into the market by creating an investment schedule. A common way to put this into practice is choosing a certain amount of the money to invest monthly or quarterly. Remember: “measure twice, cut once.”
The dollar cost averaging (DCA) strategy can also serve as a sort of “insurance.” If the markets increase during the DCA period, at least your money is working for you rather than sitting on the sidelines.
However, if the markets decline during the DCA period, that’s ok, because you will be buying while the markets are low. You’ve probably heard the popular saying, “buy low, sell high!”
How long should your dollar cost average period be?
Our typical rule of thumb is to systematically work the cash into the market over an 8-12 month period. Studies show that longer periods could actually diminish returns.
Check out the video below if you’re having trouble deciding between dollar cost averaging and lump sum investing!
