What do you do with a windfall? Perhaps you earn a bonus, receive an inheritance, or take a retirement account distribution. No matter where your cash comes from, most people understand that it’s important to invest the money rather than letting it sit in savings. But which strategy is better: lump sum investing vs dollar cost averaging? 

Let’s explore these two different investing options by defining them and weighing the pros and cons of each. After assessing any legal or tax implications with your windfall, you can determine the investing strategy that is best for your financial plans.

What is Lump Sum Investing?

Lump sum investing is exactly what it sounds like–you invest a lump of your money in a single sum all at once. This “lump sum” goes into a diversified portfolio aligned to your goals and your risk tolerance. Rather than making infusions of cash over time, you invest all of your money at once. 

What is Dollar Cost Averaging?

Dollar cost averaging is a slow and steady approach to investing a sum of money. Instead of putting in a lump of cash all at once, dollar cost averaging moves money bit by bit. Generally, people who use dollar cost averaging set up a regular schedule to invest a fixed amount of money. 

Lump Sum Investing vs Dollar Cost Averaging in Action

So what does lump sum investing vs. dollar cost averaging look like? Let’s imagine that you receive a $10,000 windfall. 

If you choose to do lump sum investing, you will move the $10,000 into your investment portfolio all at once. 

Conversely, if you decide to use dollar cost averaging, you have to set up a timetable that works for you. The first thing you need to do is decide on a length of time. Let’s say that you want to have the full windfall invested within a year of receiving it. That means that each month you will add approximately $833 to your portfolio. By the end of twelve months, you will have invested $10,000. 

No matter which investing strategy you choose, you can invest with a financial advisor or invest without an advisor. Either way, review the pros and cons of each investment strategy below and take action today!

Lump Sum Investing Pros 

There are many benefits to lump sum investing. Let’s explore why lump sum investing might be the right choice for you:

Best for Long Term Investors

Is your goal to become a long-term investor? Then lump sum investing might be the right choice for you. That’s because it gets the most money in the market the fastest. Even if the market performance dips, long-term investors benefit from having their money in the market for as long as possible. 

Avoids Market Timing

Too often, people overanalyze their investing options. As a result, they leave a lot of money out of the market. Unfortunately, that is one of the hardest investing mistakes to fix. You simply cannot reverse time. 

As a result, lump sum investing can be very helpful in terms of getting your money working for you. Even though you may not put your money in at the perfect time, it’s still better than sitting out. Remember this helpful money saying: It’s not about timing the market; it’s time in the market that matters. 

Outperforms Dollar Cost Averaging

Historically, lump sum investing outperforms dollar cost averaging. Research shows that lump sum investing beats dollar cost averaging 68% of the time.

When the MSCI World Index returns for 1976 through 2022 were analyzed, lump sum investing came out as the clear winner. That doesn’t mean it is guaranteed to always outperform dollar cost averaging. But if you are swayed by statistics, this is a pretty compelling argument in the lump sum investing vs dollar cost averaging battle. 

Avoids Analysis Paralysis 

Think about having to get into a cold pool. How do you do it? You can look at the pool from all angles, put in a foot, and continue to hesitate. By the time you finally get in the pool, it’s likely that your friends or family are done swimming. This type of analysis paralysis might be annoying or even comical on a vacation. But it can be downright detrimental when it comes to your finances.

If you want to avoid analysis paralysis, sometimes you just need to take the plunge. Lump sum investing is similar to cannonballing into the pool. After choosing an investment option that aligns with your goals and risk tolerance, you purchase your investments one time. There’s no time to pause or reconsider; instead, you jump into the market with your money and can free up the mental load for other things. 

Dollar Cost Averaging Pros 

While there are many benefits to lump sum investing, dollar cost averaging also has plenty of benefits. 

Offers Flexibility 

If you want to invest all of your savings at once, it doesn’t give you a lot of time to change your mind. (Unless you intend to keep your money out of the market for a prolonged period of time–which we don’t recommend!) But with dollar cost averaging, you can pivot your investment strategy fairly easily.

Builds Good Habits

For first-time investors, it can be hard to get started. By setting aside a dedicated amount of money every month, you can build that investing muscle. This intentionality can help you stick to your investing plans. 

Dollar cost averaging can also show you the benefits of automating your finances. By taking a set-it-and-forget-it approach to investing, your money can grow behind the scenes. Yet some people feel a great deal of analysis paralysis. Instead of spending your time overthinking or second-guessing, automating your investments allows you to make a good decision one time and enjoy the benefits on a regular timetable. 

Helps You Act Rationally 

Money can evoke a lot of emotions in people. However, the best investments tend to be the ones we make logically. When you use dollar cost averaging, you are less likely to try to chase wild hairs or invest in hot stocks. Sometimes, when people try to follow trendy market tips, they invest impulsively instead of following their financial goals. 

When you dollar cost average, you commit to a regular schedule and a thoughtful investment pattern. This helps you avoid impulses and encourages you to act rationally.

Lump Sum Investing Cons 

Lump sum investing tends to outperform dollar cost averaging. Still, it may not be for everyone. Read on to learn more about the cons of lump sum investing. 

Short-Term Market Dips

Let’s say you invest in a lump sum right before the market dips. That can lead to both a financial and psychological hit. Investors might walk away feeling skeptical or even fearful of the market.

The reality is that the stock market is cyclical in nature. Dips and even crashes do happen. If you are someone who would struggle to see the big picture when presented with a short-term market dip, this may not be the investing choice for you. 

Be Wary of Fees

If you don’t plan to keep your money in the market for a long time, you need to be mindful of the different fees and penalties you might incur. Investors may pay a penalty for accessing retirement funds early. Additionally, some investments have surrender charges. If you invest in a lump sum and go to pull some money, you want to ensure that you aren’t expected to keep that money invested through a certain maturity date. 

Dollar Cost Averaging Cons 

Dollar cost averaging can be great for investors who are nervous about investing in a lump sum. Still, there are some drawbacks to consider.

Lower Historical Performance

Historically, dollar cost averaging underperforms compared to lump sum investing. However, it is worth noting that dollar cost averaging outperforms cash. If dollar cost averaging is what keeps you from holding your windfall as cash only, then it is still an investment win! 

Lost Earnings

If you plan to dollar cost average over the course of a year, that money isn’t in the market, where you tend to see the most growth. Even if your money is in a high-yield savings account, the market tends to outperform those accounts. As a result, dollar cost averaging might mean your money isn’t working as hard for you.

Lump Sum Investing Vs. Dollar Cost Averaging: Which is Better?

When it comes to the battle of lump sum investing vs dollar cost averaging, which strategy wins? As with most things in personal finance, it depends. 

Overall, lump sum investing has proven to outperform dollar cost averaging over the long haul. This also depends on your goals. If you'd like to have more flexibility with your money than growth, then dollar cost averaging might be a better choice. If your goal is pure growth for a specific long-term goal like retirement, then lump sum is the way to go.

A good middle ground might be to invest a portion of the lump sum in a taxable brokerage instead of qualified retirement accounts that “lock up” your investments for the sole purpose of retirement. 

To help you declare a winner in the lump sum investing vs dollar cost averaging comparison, you can evaluate your progress toward Coast FIRE. Then, you can see which accounts you may want to utilize and how much time you need your money to stay in the market. Understanding the purpose of your money and the why behind your investment goals can help you determine which investing approach is right for you.

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What do you think of this lump sum investing vs dollar cost averaging debate? Are you trying to make this big decision?

Please let us know in the comments below.

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