Does Dollar Cost Averaging Apply to a Large Lump Sum?

Dollar cost averaging is an outstanding way to handle the investment of money as you accumulate it.

But let's say you have just received an inheritance of $500,000. Or you've won a lawsuit. Or the lottery. Should you invest a large amount of money in accordance with dollar cost averaging — meaning, invest a small portion of the money each month until it is all eventually invested?

No. Here's why: Dollar cost averaging is intended for the accumulation of assets, not the distribution of assets already accumulated.

The entire benefit of averaging means that by default, you are guaranteed not to receive the lowest cost available, which in turn means you will not receive the highest returns, either. Since stock prices historically have an upward bias, the sooner you invest, the more money you will make, and dollar cost averaging delays that effort.

People who try to DCA large sums into the market soon learn why their strategy doesn't work: By investing $100,000 over a one-year period, they invest just $8,333 in the first month. That means they didn't invest $91,667. What will they do with that block of cash in the meantime?

It sits in cash, earning a small rate of interest — hence the problem. Although you lower your risk by dollar cost averaging, you also lower your return. Remember, the best time to invest is when you have the money!

This also means you should invest as soon as you have money. People sometimes tell me they're saving $25 per month in a bank account. "As soon as it grows to $5,000, I'll invest," they say. If your money is sitting in a bank at 1% per year, do you realize how long it will take $25 per month to grow to $5,000? Don't wait: Invest your money effectively now.

Though all this sounds fine, you're probably unconvinced, because you know that with your luck, the stock market will crash the day after you invest your life savings.

So please don't misunderstand me. I said to invest all your money at once. I did not say that you should invest all your money into stocks at once.

Originally published in The Truth About Money

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