By Tim Courtney, Chief Investment Officer
Dollar-cost averaging is a common investment method that involves continuously making asset purchases over time regardless of market conditions.1 It’s how many people save for retirement, most commonly by contributing to a 401(k) with each paycheck. This approach helps mitigate the risk of investing everything at a market peak and takes advantage of periodic market declines by buying at lower prices during those times.
For some, another option is lump sum investing. If an investor has a lump sum to invest a—$2 million inheritance, for example—investing all of it immediately will usually produce better results than dollar cost averaging $2 million in asset purchases over a number of years. This is because markets tend to rise, with the S&P 500 producing a positive annual return about 70% of the time over the past century.2 By waiting to invest, there’s an increasing probability that an investor will buy stocks at higher prices later. Another critical advantage of lump sum investing is compounding. The earlier a bulk investment is put to work, the more time it has to generate compounded returns.
While lump sum investing generally has the odds in its favor, there are times when utilizing dollar-cost averaging can be a prudent strategy. Let’s consider the scenario of a 60-year-old who receives $500,000 as an inheritance. The same general rules apply—there’s still a 70% chance of buying at a higher price later with dollar-cost averaging.
However, there may be concern about investing a large lump sum in stocks that have recently had returns well above normal and have quite high valuations. The S&P 500 is currently trading almost 50% above its long-term average price.3
Under these circumstances it may be prudent to consider utilizing a dollar-cost-averaging strategy for some of the purchases. Rather than investing the full $500,000 at once, a balanced approach could involve allocating 50% ($250,000) upfront in an acknowledgement that markets still rise 70% of the time, while planning on investing the remainder over time to take advantage of any pullbacks or corrections that often happen following extended periods of above average growth. You may also consider putting more money to work upfront in assets that are lower priced such as value, small-cap stocks4 and international equities.5 This approach provides a measured way to gain immediate market exposure while managing risk.
One advantage of an extended dollar-cost-averaging timeline is flexibility. Suppose an investor decides to dollar-cost average over 18 months, but six months into the plan, the market drops 15%. At that point, the investor could accelerate the dollar-cost-averaging timeline. Having a longer dollar-cost-averaging window allows for adjustments based on market conditions.
While lump sum investing early is often the logical choice to put cash to work in markets, dollar-cost averaging can be a useful tool, especially when market valuations are high. For holders of large amounts of cash today, it may be prudent to utilize both lump sum and dollar-cost averaging. Reach out to your Exencial advisor with any questions you may have.
Sources
- Investopedia (5/24/23) - Dollar-Cost Averaging (DCA) Explained With Examples and Considerations
- Forbes (1/14/21) - S&P 500’s Impressive Rate-Of-Return Score: 70-25
- GuruFocus (2/14/25) - S&P 500 PE Ratio
- CFA Institute (6/19/24) - Concerned About Market Concentration and Lofty Valuations? Consider Small Caps
- MarketWatch (2/12/25) - Trump’s Tariffs Could Make International Stocks More Attractive Than U.S. Investments. Here’s Why.
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The S&P 500® Index (S&P 500®) is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
