Dollar cost averaging and lump sum investing: Take the emotion out of investing
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Key takeaways:
- Dollar cost averaging involves investing the same dollar amount into the market at a regular interval.
- Automatic investing takes the emotion out of investing.
Time in the market is far more important than timing the market. Long-term investors will utilize both the strategies of dollar cost averaging and lump sum investing to reach their investment goals.
Dollar cost averaging involves investing the same dollar amount into the market at a regular interval. In doing so, one buys more shares when the market is down, and less when the market is up. This so-called dollar cost averaging helps to maximize return in a volatile market.
Investors should consider linking their checking account to their brokerage account, and automatically investing a certain amount of their paycheck every month into an appropriate asset allocation based on their time horizon. This dollar cost averaging also has the advantage of eliminating investment psychology, as it is tempting to buy when the market is booming and sell during a crash. Warren Buffet reminds us to do just the opposite. Automatic investing takes the emotion out of investing.
As an example, a 40-year-old woman making $300,000 a year aims to save 20% of her gross income, or $60,000. She already puts $23,000 into her 401k account. For the additional $37,000, she dollar cost averages $3,083 the first day of every month, allocated 80% into a total stock index fund and 20% into a municipal bond fund.
Lump sum investing involves investing all of one’s purse at once. This strategy is more fruitful than dollar cost averaging in an ascending market, and disadvantageous in a descending or highly volatile market.
The reality is that most investors will employ both strategies. For one’s monthly paycheck, he or she should automatically invest and, thus, dollar cost average. For a windfall, such as an inheritance or bonus, if one has an appropriately diversified asset allocation, such as an 80/20 split between stocks and bonds, one can lump sum invest with impunity. Keep in mind, one’s asset allocation should become more conservative (eg, 60/40 split between stocks and bonds) as one’s investment horizon narrows and retirement nears.
For more information:
Chirag P. Shah, MD, MPH, is a soccer and Nordic ski coach, who also practices medicine and teaches in Boston. He can be reached at cshah@post.harvard.edu.
Jayanth Sridhar, MD, is an award-winning podcaster, physician and educator who is chief of ophthalmology at Olive View Medical Center in Los Angeles. He can be reached at jsridhar119@gmail.com.
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