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No one ever said investing was easy. It will test your patience and, at times, make you second-guess yourself. This tendency can increase when investing a large lump sum. Many worry that markets will crash right after they put the lump sum to work.

While I can sympathize, the reality is this rarely happens. We are somewhat predisposed to remember market corrections but largely overlook market rallies. Case in point: Most remember the crashes of 2008 (Great Financial Crisis), 2020 (Covid), and 2022 (Inflation Surge), yet few remember the nearly 30% rally in the S&P 500 in 2013, 2019, and 2021. Returns of this magnitude are something to recall, yet few do.

The question often asked is whether it’s better to invest a lump sum OR allocate over time (dollar cost averaging). The good news is that both are winning long-term strategies—but which tends to lead to a better return? My post this month explores this topic, drawing on historical data to help provide some insight.

One thing is for sure: You do NOT want to wait for a market correction to start saving, as you may end up waiting for a long time and missing out on hefty returns.

LUMP SUM

The obvious worry is markets will experience a sharp correction, resulting in an immediate short-term decline. Psychologically, it can feel more “comfortable” to wait for a market correction before investing. While certainly possible, history shows it’s an unlikely outcome.

A bear market, defined as a decline of 20% or greater, thankfully occurs much less frequently these days. Between 1928 and 1945, there were 12 bear markets, about one every ~1.5 years. Since 1945, there have been only 15, about one every ~5.1 years.

Think about that for a second. A bear market occurs, on average, only TWICE in a decade, yet many believe it is always right around the corner.

Now, in fairness, we experienced bear markets in 2020 and 2022, so they remain fresh on people’s minds. But as it goes with investing, “past performance is no guarantee of future results.”

History shows that another imminent bear market is unlikely, given that we experienced TWO in the past four years. Of course, if a black swan event such as Covid were to occur, a bear market outcome would be likely. But again, the probability is extremely low.

Now, according to a study by Vanguard, investing a lump sum in the MSCI World Index yielded a higher return ~70% of the time versus dollar cost averaging and investing in cash.

In general, the longer the period of dollar cost averaging, the greater the opportunity cost and the greater the lump sum outperformance. While this may sound surprising, markets rise FAR more often than not. Since the start of 2013, the S&P 500 has yielded a positive quarterly return a whopping 38 of the last 46 quarters (~83%)! This fact helps illustrate why dollar cost averaging over longer periods will likely lead to more harm than good.

I know what many are likely thinking right now: Market valuations are pretty “elevated,” which means the risk to downside is even higher. It’s true that markets aren’t cheap by any metric, but as the old saying goes: “The market can remain irrational far longer than you can remain solvent.”

In a nutshell, markets are impossible to time, so there’s no sense in trying! Although the lump-sum option has the highest probability of success, it also tends to be the most stressful.

DOLLAR COST AVERAGING

While this method generally leads to lower total return, it can provide a psychological payoff. During extended periods of elevated volatility (e.g., 2008, 2016, and 2022), dollar cost averaging not only can outperform a lump sum but oftentimes is the only way to get an investor off the sidelines.

Look, when markets are down 15%+, investing a lump sum can be scary. The larger the lump sum, the more daunting it becomes. This is where dollar cost averaging can help. It “forces” an investor to take action and helps remove emotion from the equation.

It is important to establish a plan beforehand and stick to it. For example, if you had $500,000 in cash, you could look at investing $50,000/week every Friday for the next 10 weeks. The potential benefits here are that you get to purchase more shares if markets continue to drift lower, and if they start to rise, at least you have invested a portion of the money at lower values.

As seen on the chart above, the cost-averaging method would have yielded a better outcome during the height of the Financial Crisis, but if an investor dragged their feet and waited a few months, the lump sum significantly outperformed. Herein lies the problem: Unless you can time markets, you are likely to end up missing out on returns, which can cause even more stress and anxiety versus investing a lump sum.

As a reminder, the S&P 500 hit a 13-year LOW on March 5th, 2009, and market sentiment was near a 20-year low. What happened after? The S&P rallied nearly 32% from April through September, one of the best six-month rallies in history.

While there is no magic eight ball, generally speaking, the sooner you invest, the better. Of course, there are a few outliers, but the data is pretty clear.

That said, dollar cost averaging does work, and if that is the only way to get an investor off the sidelines, so be it. The trade-off is that this strategy will likely lead to a lower long-term return.

Discuss your situation with a fee-only financial advisor.