Lump-sum vs dollar-cost averaging
| Approach | What it is | Best for |
|---|---|---|
| Lump-sum | Invest it all at once | A windfall you already hold and won't need -- maximizes expected return |
| Dollar-cost averaging | Invest a fixed amount on a schedule | Money arriving each paycheck, or calming nerves about one big deposit |
Two situations people mix up
Two situations get confused. (1) A windfall you already hold: lump-sum wins ~2/3 of the time. (2) Money arriving every payday: you are dollar-cost averaging by definition, and that is exactly right -- you invest as you earn. DCA-ing a windfall trades a little expected return for peace of mind, which is fine if it keeps you invested. (Ties to pf-2: time in the market beats timing the market.)
Deciding how fast to invest a lump sum
Dollar-cost averaging as a behavioral tool
What the evidence says about a windfall
Why a lump sum feels scary
The dread of investing a windfall right before a drop is loss aversion -- losses sting about twice as much as equal gains feel good. Behavioral Finance module bf-3 (Loss Aversion) unpacks why, and why dollar-cost averaging a windfall is often a fee you pay for peace of mind rather than a better return.
Sit with the ideas.
Vanguard's research found that investing a windfall all at once (lump-sum) beat spreading it out (dollar-cost averaging) about two-thirds of the time. Why?