Investors come in all shapes and sizes.
Some like high risk some like low risk.
Some people are investing for a house, a boat, or their kid’s college.
Other investors are looking further out to retirement.
Some people have just gotten a big bonus at work, and don’t want to blow it.
It doesn’t matter what category you fall into, there is a method of investing that fits your investment and personal risk tolerance. If you would like to invest, but you’re wondering what strategy to use, then this post is for you.
Here, we will discuss two investment strategies: Lump Sum Investment and Dollar Cost Averaging. If you are a new investor and you don’t know where to begin, then read on. We’ll take a look at what these investment strategies are, and how you can do both to get the best outcomes.
Let’s get started.
What is Lump Sum Investment and How Does it Work?
A lump sum is a single complete sum of money where you invest an entire amount at once. Rather than spreading out your investments over time, you would take the full sum and invest it upfront. When people invest all at once, they are hoping that the stock market only goes up from here…and they “bought” in at a low point. Because we believe the market will be higher than it is today over the long term, investing all your money at once can make a lot of sense… unless your emotions get involved. If you are emotional with your money, dollar cost averaging might be right for you. Keep reading.
What is Dollar Cost Averaging and How Does it Work?
Many people consider dollar cost averaging the safest way to invest. But most people still need a complete guide on how to invest using the dollar cost averaging method. But first, what is dollar cost averaging?
Dollar cost averaging refers to a hands-off approach of investing where investors invest fixed amounts of money into an asset at regular time intervals.
It doesn’t matter that the price of the asset changes over time. If you choose to use the dollar cost averaging method, it means that you choose to invest your money in equal portions, and at regular intervals regardless of the ups and downs in the market.
Dollar cost averaging is great for investors who cannot manage the highs and lows of the market. This can help investors manage risk and remove the emotional stress of market volatility. By buying at regular intervals, you can buy at highs AND lows…
This method is ideal for the inexperienced investor as well as the investor who is averse to risk.
Lump Sum Investing or Dollar Cost Averaging; which is Better?
There is a time where the price of an asset increases over a certain period of time. Then there also is a time when it decreases over a certain period of time. In other words Bull vs. Bear markets!
Dollar-cost averaging helps to remove the emotions from investing by scheduling your investments at regular intervals regardless of the market conditions.
For example; if you want to invest $3,600 but aren’t sure when the optimal buying time is, you can dollar cost average. That way, you schedule your investment to put in $300 over the next 12 months.
Thus, whether the market is up or down tomorrow doesn’t matter. You win when the market is high because your current investments will go up and when it is low you get to buy more shares for less money
Lump sum investing, on the other hand, has to do with investing all your money at once. So instead of spreading out your investments over time, you invest the full $3,600 sum.
Which investment strategy is better?
Both investment methods have their advantages as well as their downsides. Neither is better than the other. You can use dollar cost averaging to limit your losses should the market take an unexpected nosedive. This is because you didn’t invest all your money all at once.
But while you may be lowering risks and limiting your losses, dollar cost averaging will make you lose out on overall return potential. When the market rises, you only invest little by little, and so only the amount invested at the market bottom will get the high returns.
Lump sum investing is a riskier venture. But it has the potential to bring much higher returns. It exposes you to the entire risk if the market falls. But you gain the most when the market booms.
Also, when you make scheduled investments regardless of current economic conditions, you will buy more shares when prices are low and fewer shares when prices are high.
For instance, if you invest $3,600 over 12 months, due to market conditions, you will buy in at various price points. Eventually, your average price per share may turn out to be much lower than if you tried to pick the optimal price and invested all your money at once.
Making your investment at once means that your price per share depends on the current market conditions at the time you made the investment purchase. Lump sum is the best choice in a long term uptrend. But in a volatile down trend, dollar cost averaging is the best option to go for.
The Bottom Line
Whether you use dollar cost averaging or lump sum investing, you still have some work to do. Dollar cost averaging helps you invest without hassle. But you first have to do the work of choosing an appropriate asset that you should invest in.
Similarly, before you put a lump sum into an investment, you want to first be familiar with your risk tolerance. Ensure that you can sleep well at night during periods of market volatility before you put your money to work.
For most investors, a combination of lump sum investing and dollar-cost averaging is the best choice. They can own small bits of hundreds of stocks. Using both strategies, they never have to worry about one company’s failure wiping out their portfolio.
If you want to be sure about the best investments to make, The Art of Financial Planning is just what you need. We can help you make the best investment decisions, even if it’s your very first investment. We can also give you more information on other strategies that you can use to grow your wealth.
Let us help you on your way to financial independence. Contact us today.
