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My Great Aunt passed away in October at the age of 101. She lived a long and full life. She never had any children of her own, so my Dad and his sister became the children that she never had. In turn, my sister, my cousins, and I became her grandchildren.
She loved going to church and a good glass of whiskey (preferably Lagavulin) after dinner every night. She worked at the CIA until she retired and then look a job at a florist. In her old age, she was a tough nut to crack. I can’t imagine that she put up with too much in the old boys’ club that was the CIA back in the day.
My Great Aunt’s Estate
My Dad is the executor of her will and has been working to finalize everything. I’ve never been an executor of a will, but it seems like a lot of work. You would think that it’d be easy to prove someone had passed away and quickly close up the estate. I definitely didn’t realize how much paperwork was involved in order to get everything in order.
He recently informed me that I would be receiving a small inheritance. I honestly didn’t think I would receive anything, not because she didn’t love me, but because I really didn’t think she had any money.
Her husband passed away while she was in her 40s. As a result, she was on her own financially for the rest of her life. She always seemed to be scraping by on her small government pension, so when I found that I’d be receiving a small inheritance, I felt a little guilty. I would have much rather seen her spend that money on herself.
I am incredibly grateful for the inheritance though, but I want to ensure that I use the money wisely. So now I am debating what is the best way to do so.
The Best Way to Invest
A couple of months ago, I went through an exercise trying to determine the best day to invest in the stock market. I figured that based on this exercise, it probably made sense for me to figure out how often I should dollar-cost average.
I started researching to see if there is a specific interval that made the most sense. Financial experts say that you should dollar-cost average, but rarely does anyone say what the intervals should be. I researched far and wide to figure out if it made more sense to dollar-cost average weekly, monthly, quarterly, or yearly.
What Is Dollar-Cost Averaging?
Before I get too far, I want to make sure everyone understands what dollar-cost averaging is. Dollar-cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. Since stock prices fluctuate every day, the investor can purchase more shares when prices are low and fewer shares when prices are high.
Do you know what I found in my research? Nothing. I couldn’t find anything findings to support the specific intervals that you should buy into the market. There was advice saying you should buy monthly or quarterly. But I couldn’t find any specific research to affirm this point of view.
Now here’s the even crazier part about what I found. Dollar-cost averaging is actually not the best way to maximize your returns. Do you know what is the best? Lump-sum investing.
Timing the Market
If you find that shocking, you’re not the only one. Let me walk you through some of the research. But before I do, let me reiterate one of my favorite quotes. “It’s not timing the market, but time in the market that matters.”
Isn’t dollar-cost averaging a type of timing the market? Well, with dollar-cost averaging, you essential admit that you won’t anticipate the trajectory of the market. You space out when you will buy into the market, so that it hopefully evens out over time. So if you buy into the market when it’s too high one month, theoretically the market would be lower in the future to balance it out.
In theory, it sounds good to do this. But, what are the actual results?
Why Lump-Sum Investing is Better than Dollar-Cost Averaging
Vanguard did a study where they backtested a portfolio using the S&P 500 during a rolling 10-year period from January 1926 through December 2011. This means that essentially that they looked at January 1926 through December 1935 and then every monthly and yearly iteration in between and through December 2011. This equaled 1,021 iterations in total, in the US stock market.
Vanguard found that lump-sum investing outperformed dollar-cost averaging roughly 66% of the time, investing solely in the S&P 500. Vanguard says the results are “really quite intuitive. If markets are going up, it’s better to put your money to work right away to take full advantage of the market growth. We found that any factors unrelated to market trends had a minimal impact on the results.”
The study goes on to show that if you had lump-sum invested using a 60/40 stock to bond mix, that your portfolio on average would beat dollar-cost averaging by 2.3%.
These numbers were shocking to me at first, as I always thought that dollar-cost averaging was the preferred methodology.
So, Why Dollar-Cost Average?
Reading through the various commentary, it comes down to the psychological benefits of dollar-cost averaging.
The biggest down side to lump-sum investing is that people try to time the market. They think that if they have all this money on the sideline that they need to pick the perfect entry point. Although, with lump-sum investing, one is suppose to jump into the market immediately. However, when people do try to wait for the ideal time, their analysis causes paralysis. In turn, experts push investors into dollar-cost averaging to alleviate some anxiety.
Investors are inherently scared to invest all of their money at one time. If the market goes down, the sense of regret can be unbearable. By using dollar-cost averaging, these investors can sleep better at night not worrying as much if they happen to buy high because they have a chance to buy low at a later date.