Perennial Financial Planning Questions: Should we Dollar Cost Average into the Market?

There are a handful of questions that most financial planning clients bring in our front door. The answers can vary widely, of course, since the situations folks face are so very different. But there are some commonalities, some points of contact — and in this series, we’ll look at a few of these key questions, and see what general answers we can offer.



A few days ago, I spoke with a prospective client who recently (a) inherited a larger-than-expected estate from her parents, and (b) downsized her home, creating a sizable capital gain. We talked a little about current market conditions, and what the market turmoil of the last several months might mean for long-term investment opportunities for her large lump sum. She asked me “Don’t you think it would be smart to invest a little of this at a time over the next few months?” — and was surprised, I think, when I said no.

Dollar-cost-averaging (DCA) is widely believed to be always a good idea. Americans seem to expect our financial advisors to talk about the wisdom of buying a little today, and a little tomorrow, in order to take advantage of changing prices. Sure, I may buy some shares at a high-ish price today, but I got some at a lower price yesterday (or last month), so it averages out. DCA plans are often presented as the best way for a beginner to get her assets into the market.

For some kinds of investor, I think, a DCA plan works great. For contributions to a 401k account, or investment of extra savings into a taxable account, it’s terrific — having an automatic plan, according to which you make periodic investments of a specific amount, is one of the best possible ways to make sure that you’re investing for your future. The Motley Fool points out three key benefits: a DCA plan helps you to avoid trying to “time the market”, it makes investing more rational and less emotional, and it can help to smooth out the bumpy ride of the markets. Let’s get your salary deferral invested, and trust time and compounding to work their magic!

But with a lump sum, a biggish chunk of cash that lands in your hands all at once, a DCA plan may not be the best idea. Let’s take a look at this diagram, and think about the difference between a DCA plan and lump-sum investing.

DCA Chart

Let’s start our DCA plan in January, and invest 1/12th of our lump each month for a year. If our investment (one stock, one mutual fund, or diversified portfolio) takes Path A, here, and goes up during our DCA period, we’ll be pretty disappointed, won’t we? After all, had we invested the whole thing in January, we could have benefitted from the whole of that up-trend. If our investment follows Path B, then we’ve done a lot of extra work for no real benefit, since we end up in the same place anyway. If the investment follows Path C, the DCA plan will have “worked”, in that we’ve ended up with a lower average cost per share, but — well, what if we had waited to invest?

Of course we can’t say whether the markets will perform more like Path A, Path B, or Path C over the next year. We could probably line up a half-dozen respected economists and pundits with arguments in favor of each possibility. But let’s look again at those paths: If we invest our lump sum all at the beginning, we have one great result, one “meh” result, and one bad result. If we hold our cash for a year, we’re in the same boat. But if we DCA, then in two of the three scenarios here, we end up wishing we had not undertaken a DCA plan, and in the third we’ve just wasted time and effort. Interestingly, over the last few years, research from Vanguard and from retirement investing expert Ed Slott supports this conclusion.

A DCA plan, then, can prevent the worst possible outcome, at the cost of also preventing the best outcome. We want to make sure that you make a choice you can be okay with — that you can stick to your strategy. If you’re okay with the foregone opportunities of the DCA plan, we can certainly help put that together for you. If you’d rather go ahead and invest the lump sum, we can do that instead. But let’s not make an assumption about the best, “smartest” strategy without having the conversation.