Should I make a lump-sum contribution to my mutual fund account or take advantage of dollar-cost averaging?
August 2nd, 2010
I received some inheritance money that I’d like to invest for retirement. I plan to open a mutual fund account with Vanguard and begin investing in index funds. Should I invest the entire lump sum at once or keep it in a high-yield money market account and fund the mutual fund account monthly to take advantage of dollar-cost averaging?
Assume I have no bad debt, have already established an emergency fund, am contributing to a 401(k), and am funding a Roth IRA (also with Vanguard) to the annual max.
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Hello,
There is no one correct answer to this question, as it depends on your approach to investing, your current view of the market and your risk tolerance. Lump sum investing might appropriate for one investor while dollar cost averaging might be better for other investors. Dollar cost averaging is probably most appropriate for less experienced investors that have a lower risk tolerance. Lump sum investing best suited to long-term investors with a higher risk tolerance
I hope this helps.
Michael A. Weiss, CFA
The Editor
The Mutual Fund Investor
http://www.mutualfundinvestor.net
Why not open a broker account..you can still buy vanguard and lots of other mutual/index funds and stocks and bonds and gold and lots more…………..e trade or td ameritrade..cheap commissions
I like dollar cost , but how about a few funds……..all eggs in one basket………NOT WISE………….
I would dollar cost average over the next year on a monthly basis. I would use funds that fit into the following categories:
US Large, US Mid Cap, US Small, Foreign Large, Foreign Small plus some Real Estate, Natural Resources and Precious Metals. You’ll have almost all the bases covered.
I would not be surprised at all if you were to get answers supporting the two different strategies. There is something to be said for either. In general though–and I would certainly like to hear the argument opposed–dollar cost averaging is generally an approach supported by proponents of a regular monthly type contribution. I guess it might make some sense in that context for those who do not have the ready cash to invest. But in general equity values tend to over the long term consistantly increase in value in general. And that is particularly true of mutual funds indexed or not. There certainly are exceptions to that as happened to certain mutual funds and index funds from 2000 to 2003 and it will happen again. Perhaps even this and next year. I do not know exactly what you might have in mind by the term. But I will have this to say. I would not invest it all into mutual funds at this time. But I would put a good percentage in. After all you do want to get the advantage of the long term trend. You could reasonably invest 25% now, 25% in 6 months, 15% in 12 months and 15% in 18 months. The other 20% should in my opinion remain in the money market account. Sort of a safety valve. Also I would caution you about puting it all into index funds. I know that they are very popular today but there are some disadvantages to them that you need to seriously consider. One is that some, especially the 500 index fund, are not very diversified. 25% of your assets are invested in about 20 stocks. The other 75% in the other 450. Also that particular fund is all U S equities. That also is not diversified. Vanguard has a more diversifed fund that is not an index fund that you should give consideration to. It is the Global Equity Fund. Only 35% of that fund is invested in U S equities.
Pesonally I would invest a lump sum of 25% of what you have allocated in 2 separate stocks (which are in different sectors) now and dollar cost average (regularly) the other 75% of the $$. I would also consider selling a part of the profit on the stocks that you gain 33% profit on and invest it in the stock(s)that you are losing in.
With your other investments you have set up I would put it all in now. Dollar cost averaging is a good thing especially as money becomes availabe to invest but if you have a lump sum and you don’t invest it in existing funds you have to do something with it. You could fund laddered CD’s coming due every 3-6 months and then filter into mutual funds which would give dollar cost averaging effect but you would be gambling that your CD rates would be more than getting it into mutual funds right away.
If your either going dollar cost averaging or full investment into a mutual fund I would say go with the mutual fund.
Even though you are diversified now that does not or should not keep you from further diversification. Instead of funding said mutual fund, split up lump sum into many different funds.You can never be too diversified.
You are asking a very good question. Unfortunately, I’m not so sure this is the forum for which you should rely upon a good answer. Even with the “assumptions” you have provided there are still some fundamental questions that should be answered in order to have your question addressed in a responsible manner. For instance; how much money do you have to invest; what is your total portfolio worth (401(k) Roth, etc.); what types of investments are already in your portfolio; how long before you retire; and what does your personal income statement look like (etc…etc…etc…)? You will notice none of these questions deal directly with portfolio allocation and whether you are “properly diversified” for the level of risk you are willing to assume. I could go on regarding the type of information that should be gathered, but I think you get the point.
I don’t mean to bum you out, but trying to make a decision as to whether or not you should invest a lump-sum or use a DCA strategy for your inheritance in light of all the other assumptions you noted, I think is an over simplification of proper financial planning. Unless you are willing to do some real investment planning for yourself, you should seek the (face-to-face) assistance of a financial planning professional.
Just as a side bar regarding lump sum versus DCA; I’ve seen academic studies that suggest lump sum investing is better than DCA. This is of course providing you have the lump sum to invest. Keep in mind however, as with any study dealing with performance numbers, they are looking in the rear-view mirror in order to “suggest” what may happen in the future. With respect to DCA, it has been one of those strategies that has been around for quite some time. I think it’s a great strategy for individuals “just starting out” and have a long-term time horizon (5+ years). However it too has its drawbacks, particularly for those individuals who have the resources to invest up front. But again it all depends on the unique circumstances of the individual. Good luck!